Small Bank Stocks
Small Banks and Activist Hedge Funds: Your Pocket Aces

Small Bank Stocks
Small Banks and Activist Hedge Funds: Your Pocket Aces

Tim Melvin

During what we now call my “single years,” I played a lot of poker, most of it online.

After years around the psychological soup of the stock market, I found the combination of math and psychology to be highly entertaining and occasionally profitable.

I played then, and still do, a very tight, aggressive style of poker. I always kept in mind poker legends Doyle Brunson’s advice to get my money in the middle when I had the best of it.

I would go on ling winning streaks, but always got caught by gamblers ruin and my own ego. I would take a carefully built bankroll and try to move up to higher limits and get crushed by players who were a lot better than I was. (They were also very inconsiderate. They never even bothered to thank me for my generous donations to their stack.)

Then I ran across David Sklansky’s simple system for tournament poker.

He designed a simple approach for tournament poker designed to getting your money in the middle with the best hand most of the time. A casino owner wanted a system for himself and his daughter (who had never played so much as a single hand of poker) to play in the World Series of Poker.

It was simple tight super aggressive system. If you got Aces, Kings or Ace-King suited, you pushed all-in no matter what happened before the betting got to you. If no one had raised in front of you, you moved all-in with your chips with any pair or connected cards of the same suit.

That simple system allowed the casino owner to cash in a smaller tournament and the daughter made it to the very end of the first day of the World Series against the toughest competition in the world.

In his book Tournament Poker for Advanced Players, he used that simple approach to develop a system of what hands to play based on your position on the table and how players in front of you had acted with their hands.

Here were only two actions taken. You moved all-in based on cards and position or you folded.

I used the system with fantastic results from then on. The key was to play the lower limit tournaments on line as you were playing against less experienced players who thought poker worked like it did on TV. They played every hand and called with nothing in their hand because they saw their heroes on TV do it that way.

No one told that the real key to winning was folding many hands. In the lower-level ten-person sit and go tournaments online it didn’t win all the time but it did win often. It was super tight and super aggressive.  It was like my own little poker ATM for several years.

We can take the same approach to the markets that David Sklansky did for tournament poker.

We can base our approach on where we are in the market cycle, and which strategies and types of stocks to own based on what we hold and where we are in the market.

We want to play the same type of tight aggressive game in the markets that he suggests for the poker table and get out money in when we have the best hand.

Much like in poker we want to avoid the markets that have a lot of pros in the game and can push us around with the size of their stacks and opposing strategies. We want to stay in the smaller cap, less liquid approaches and the research suggests that we stick with stocks that have classic value characteristics. In his study “Liquidity as an Investment Style” Professor Roger Ibbotsen found that from 1972 to 2011 “Among the high growth stocks, the low-liquidity stock portfolio had an annualized geometric mean (compound) return of 9.99% whereas the high-liquidity stock portfolio had a return of 2.24%.

Among the high-value stocks, low-liquidity stocks had an 18.43% return whereas high-turnover stocks had a return of 9.98%. Value and liquidity are distinctly different ways of picking stocks. The best return comes from combining high-value stocks with low-liquidity stocks; the worst return comes from combining high-growth stocks with high-turnover stocks. “It just makes sense to me that we stay with the less liquid value oriented stocks as they have historically given us the highest returns.

There is one investing strategy that I call the Aces approach to long term investing. You can use it anytime and you can be aggressive about getting your money in the middle.

Last October, analyst Matthew Kelly and his team, then at Sterne Agee, published a report that outlines what happens when you buy community banks stocks after an activist investor specializing in small banks files a 13D the target banks outperforms the market by a substantial amount.

The report examined the decade leading up its falloff 2014 publication and found that “These funds have a solid track record of success with 29% of the banks examined eventually being sold and outperformance versus the NASDAQ Bank Index which averaged 28 percentage points.

Most of the banks targeted are headquartered in the Northeast and Midwest markets, remain small ($740 million average asset size), and are less expensive (average price-to-TBV multiple is 94%).  For the record the index averaged about 17% during the activist holding periods was roughly 17%.

There are other ways to make money in the stock market but smaller banks with solid balnce sheets and loan portfolios have always been a sound investment. When you buy those that have an activist investor whose specializes in community banks they offer outstanding long term returns regardless of where we are in the market cycle.

It is like being dealt Aces every hand.

You might not win all the time, but you are going to win often and you will win large pots.


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