The Conservative Investor Digest

I am very excited about the company I covered in this month’s edition of The Conservative Investor Digest. It is a somewhat small community bank stock that has delivered 24% annual returns since its IPO in 1997, meaning it would take a $19,600 investment at the IPO to have a million dollars today.

It benefits from a low dividend payout ratio that allows it to have an ongoing stream of cash to headquarters that can be deployed to make acquisitions or to open additional branches (across the entire bank, it has less than 1,000 branches in total.)

Most impressively, it has been able to deliver this excellent growth without sacrificing quality. The amount of charge-offs and non-performing loans at the bank are much better than the industry average, and the bank even managed to grow profits and raise its dividend payments during the financial crisis.

Charlie Munger was most likely correct when he stated that community banks are an underappreciated sector of the economy. The largest ten banks in the country get all the attention, and also took the most significant risks during the financial crisis. This has led to a large amount of throwing the baby out with the bathwater, as there are many small banks with sound lending practices that make great investments but don’t get offered by Wall Street nor by retail investors that are prejudiced against the sector.

The bank I profile benefits from a growth-through-acquisitions strategy that does not require loading the balance sheet up with debt. This bank has made seven important acquisitions since 2010, and each bank acquired had better performing loans than the industry average (and three of the seven had loan portfolios that were better than the firm I profiled.)

It’s a situation where they are mutually self-reinforcing lollapalooza effects: it doesn’t have many bank branches, so each branch opened adds to earnings by a good clip. The dividend payout ratio is so low, so the growth can be self-funded. Because it is small, even modest-sized acquisitions are surprisingly helpful to earnings. The lending is pretty plain vanilla, making risk assessment easy. And given that interest rates are expected to rise in the next couple years, it will also benefit from the tailwind of rising net interest income.

This bank has a proven track record of making great deals, and it is worth noting that the 24% annual returns since 1997 weren’t just the result of a mispriced initial public offering. Even if you bought in 2007–right before the world had any clue of the financial crisis to come–you would have done even better and generated 28% annual returns over that time frame.

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