While I generally like it when a bank stock is being undervalued by the market, I really love it when a bank stock is being undervalued by the market and there is a catalyst on the horizon that I think will make the market revalue that bank stock higher. It’s great to be right in picking stocks that are undervalued, but it is profitable to pick those where there is a good chance that the market will soon realize its mistake. Ideally, the catalyst is something pretty objective actually occurring, like oil prices going up or the results of an investigation. In that type of situation, there is a fact that has changed, which provides a reason or excuse for the market to reconsider its view of a stock.
The absence of any change in facts or circumstances, however, is a trickier situation, particularly when the market seems to be expecting something bad to happen. In such a case, the non-occurrence of the expected bad thing, presumably, doesn’t mean that the bad thing won’t happen, it just means that it hasn’t happened yet.
While I recognize the logic of that type of thinking as applied to many cases where the market expects a bank’s results to stumble, in some circumstances, it might be better to listen for the dog that doesn’t bark in the night.
A perfect example of this is Bank of the Ozarks (Nasdaq:OZRK). Despite its uncanny record of stellar results, it still, in my mind, is significantly undervalued by the market. A large part of the reason for that is what I would call a rich man’s problem—it is just too consistently, too profitable for many to believe that its model is sustainable. Along those lines, it was the target of a, in my mind, very uninformed and unsophisticated public attack a few years ago, which probably first really dented the performance of the stock that had, prior to that, been somewhat of a market darling.
If I had to list the common bear case arguments against Bank of the Ozarks, I would say that the three biggest are credit, growth and funding. I won’t go into Bank of the Ozarks differentiated business model—their recent management comments from their earnings release yesterday do a great job telling their story—but the executive summary of the bear case is that (1) their construction loans will blow up,(2) they will not be able to continue to make construction loans at rapid pace and/or (3) they will run out of deposit funding.
None of these expected bad things has, so far, come to pass. The real question is how many successive quarters of bad things not happening does it take for the market to grasp “the significance of the silence of the dog”?
P.S. Releasing management comments along with the earnings release is a great practice that I hope other banks adopt.