Bank Stocks Worth Buying

 In this podcast, Motley Fool senior analyst Asit Sharma discusses:

• RH wrapping up a rough fiscal year.
• How the retailer's great margins during the pandemic have gotten... less great.
• Electronic Arts and Roku joining the list of tech companies laying off employees.

Motley Fool senior analyst Jason Moser and Motley Fool contributor Matt Frankel take a closer look at beaten-down bank stocks with strong fundamentals.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on March 30, 2023.

Chris Hill: Retail gaming, entertainment, bank stocks. In other words, just another day on this little podcast of ours. Motley Fool Money starts now. I'm Chris Hill. Joining me today, Motley Fool Senior Analyst, Asit Sharma. Good to see you.

Asit Sharma: Chris, it's good to see you. Thanks for having me on.

Chris Hill: Let's start in retail, and a rough end to the fiscal year for RH, the company formerly known as Restoration Hardware, posted fourth-quarter profits in revenue that were lower than Wall Street was expecting. This is one of those businesses, fairly or unfairly, that I think gets lumped in with the group that comes under the heading, pandemic darlings. Because if you look at a stock chart over the last three years of RH, there was a great run-up because people were investing in their homes and RH sells high-end furniture. It's been a pretty bumpy and steady trip down the last year or so. Stock down about 25% or so. But in terms of the results, this just hasn't been a great past 12 months for the business.

Asit Sharma: I agree, Chris. Gary Friedman, CEO who always delivers very colorful conference calls, read his letters if you get a chance, he's very fun writer. He mentioned a lot of factors that influenced the result, and coming out of the pandemic was one of the big factors. RH is still talking about that boom, and very honestly telling shareholders, look, we're trying to discern what is maybe some permanent gain out of our pandemic boost and what just isn't going to come back. Again, the other part of their narrative is a kitchen sink narrative. Now, it's a very upscale kitchen sink, because this is RH. But they were talking about the effect of inflation and interest rates and a banking crisis that no one foresaw coming, and how all of this played into their results.

This is one part of the narrative. The other part, which I'm starting to question just a bit, is this long-term vision for RH in which they keep expanding, they're expanding now globally with upscale stores, with full-service restaurants, they have more and more of what they call design studios throughout North America. Really bumping up the capital expenditure and making a higher overhead expense hurdle for themselves every quarter, but with that long-term view that there'll be this luxury leading brand and it's going to have a pay off down the road. I was just curious, Chris, what about this trajectory? What do you think?

Chris Hill: It reminds me of something Emily Flippen talked about last week when she was talking about Chewy, which is a business she studies and is a shareholder of, and part of what Emily talked about was Chewy's plan to expand internationally, how she was skeptical of that. This is not exactly the same type of plan that Chewy is trying to execute, but RH strikes me as a good business with a ceiling that maybe is lower than Gary Friedman thinks it is. I agree with you, and thank you for calling out his commentary. Friedman is one of those CEOs who is pretty clear with his communication.

It's something I appreciate and I think for any investor who's looking to check the box of CEO management teams, what are they projecting? Friedman is a straight shooter. But part of me looks at the long-term chart of RH, looks at where the stock is now relative to before the pandemic. I think if you take out the pandemic, this is probably about where the stock should be. This has been a steadily but slowly growing business for a long time. I said at the top, fairly or unfairly, they get lumped in with pandemic darlings. I think it's fair. I don't think it's unfair in RH's case. I think it's completely fair.

Asit Sharma: True. I like that reasoning. This also calls to mind the strategy itself. Will this produce more than decent returns? I'm not so sure, because RH has this idea that they're going to be the arbiter of taste in the home, this is their phrase, not mine. They also talk about reaching scale in this endeavor. The issue with that becomes in a world where the global economy seems evermore fragile. GDP, when you look at it distributed across the globe, is faltering. Some of us, maybe I fit in this category, when times get tighter, I let taste go a little bit to the wayside. When money is flushed.

Yeah, I want to be as tasteful as the next person in building out my house and having smaller innovations. But this business strategy over the long term I think depends on a global economy that is humming, where there's increasing disposable income among higher affluent groups of buyers and those who are coming up that ladder of affluence are striving, and so they see RH as an aspirational brand. What happens in an environment where things are flattening out and people are a lot more cautious with the dollars they're spending on their homes?

Chris Hill: Absolutely right. Friedman strikes me as someone who is smart enough to realize that when you are trying to position your business as the arbiter of taste, there's a limited addressable market. Let's just remove this industry and just go straight to restaurants. If you want to be a high-end restaurant and be an arbiter of literal taste, you can do that. You're never going to have the footprint that McDonald's does. You're just not.

Asit Sharma: True. That interestingly enough factors into their overall margins. That's a hard business to make money. We understand that, OK, this is a lead-in to buying other goods from RH, and it's a novel idea. But it brings to mind, Chris, just a bigger picture question that I think investors are going to be asking this year, which is, look, you had great margins during the pandemic, 22% operating margin, 25% operating margin if you take it on an adjusted basis. Now operating margin is skating I believe toward the mid low teens is what the company said in its press release when we're looking at the outlook for the coming quarter. In that world, how do you sustain all of this taste building? We'll see. We've talked about RH on this show before together I'd love to come back and let's take a look later this year to see how they're faring with this game plan.

Chris Hill: Two more tech companies are announcing lay-offs. Electronic Arts and Roku both announced they're cutting 6% of their workforce. Both companies are talking about how they're striving for greater profitability. Obviously, it is tough for the people who are losing their jobs, for shareholders of these two companies. Shareholders are probably hoping this works out on the long run because unlike what we've seen in bigger tech companies with these types of announcements, shares of Electronic Arts and Roku are not moving higher in any meaningful way on this news.

Asit Sharma: True? I love Chris that you point out that both had a 6% cut to their workforces in their reorganizations. Both are paring down real estate, and I should say too, and it's never a happy thing to hear that a company has to lay off employees. But I thought I was reading the same 8K press releases. They are so similar, but two very different situations. Perhaps not so surprising that the stocks haven't moved that much. Let's just take Electronic Arts first. It's about twice the size of Roku by revenue, but this is a profitable company.

It's a company that has a very nice cash flow. It's got some great gaming franchises. They are in that camp of companies that signaling to shareholders, look, we get it. You want us to operate as leanly as possible. The macro-environment is uncertain, so we're trimming to ensure that we keep profits flowing to the bottom line and that cash flow which you expect is going to be there. I mean, this is a company that actually pays a dividend as a growing tech company. I think shareholders are like OK, it's about time. Reading every other company that we own interests in has done the same.

Nothing there that's going to surprise shareholders too much and send the stock through the roof. Roku's a different story. Other great company, as I said, about half the size in terms of revenue. But having a tough time as the business split between hardware and its platform revenue, the advertising market has been soft. They spent a tremendous amount on research and development. In the last year we've seen Roku bleeding on the net income side. It's turned cash flow negative. Maybe shareholders, there's a bigger restructuring might have made us more excited, but we'll take it.

Chris Hill: In the case of Electronic Arts, as we get closer to July, which is the date that Microsoft has maintained, will be the closing of the Activision Blizzard deal. The closer we get to July Asit, the more I feel like more investors and more people in the gaming industry are just holding their breath, waiting to see what happens if that deal closes or not. Am I the only one who feels this way or are there others out there who are just like, no, this is a pretty big shoe and it's going to have ramifications, not just for Activision, Blizzard, and Microsoft, but for other gaming companies as well.

Asit Sharma: Chris, I think you and many other investors are watching this like a cliffhanger video game. I mean, it looked for a time like yes, there would be some antitrust regulatory exploration, but the deal is going to go through, then things look very dire. The latest indications are maybe the deal will actually pass muster here and in the states and it goes through here, we have a big acquisition. There's wide-ranging implications. One is that big tech may still be able to throw it swayed around without having to fear big interference on the regulatory side, it would be a huge win for Microsoft just in that arena. Two, what does it say for the rest of the industry? I don't think this would be the last company to be acquired by a medium or big tech sized company. You're right.

The story lines here are growing more intense as July approaches. It also has some implications for innovation. Like what does it take in this day and age to start a company that can compete with really well-funded outfits like Activision, which are backed by these deep pocketed, mammoth tech companies. Back in the day, it took just a couple of employees in idea and good programming skill set. It takes a lot more today not to say that viral ideas don't still push start-ups in front of venture capitalists. But the pipeline of video game development, it's a lot more clotted than it used to be in terms of how you can get an idea off the ground and it started growing company.

Chris Hill: Between this and the next report we get out of RH, there is definitely going to be stuff to watch this summer. Asit Sharma, always great talking to you. Thanks for being here.

Asit Sharma: Much fun, Chris. I really appreciate it.

Chris Hill: Our bank stocks and opportunity for investors or just the beginning of a falling knife. Jason Moser and Matt Frankel look at some beaten-down banks with strong fundamentals, including three that Matt recently bought.

Jason Moser: Hey, Matt. Is great to catch up with you again. These last few weeks have been a fascinating stretch for the banking industry. While it feels like maybe the contagion has been somewhat contained, and let's hope that's the case, there had been some ongoing impacts from this banking crisis that are really worth talking about. I think so and I'm glad we have here today. Want to start with just this article that you and I were reading the other day.

This big trend that we continue to see is money flowing out of the small Regional Banks and into the big banks. Consumers are scared. Investors are worried. That's all very understandable to an extent that investors also seem to smell opportunity here, retail investors in particular, and according to VandaTrack, which is a firm that follows this data, investors have plowed more than $200 million into several regional banks here recently. Now, Matt, we're all for opportunistic investing here, of course. But I wonder, do you think maybe this is an old little bit hasty?

Matt Frankel: Maybe it, it depends if they're taking calculated risks here or not or if they're just treating it as a feeding frenzy, if you will. It reminds me a lot of the crisis in '08, '09 when a lot of stocks started plunging because there were serious trouble in the business model, not necessarily the individual companies. Some ended up being fine, like for example, Sirius XM traded at $0.09 a share at one point in '08 because it looked like it was going out of business and that one turned out to be fine. But then a lot didn't turn out to be fine and people lost everything. That's really the, caution here is that you want to make sure if you're investing in regional banks right now, there are some bargains, so they're not all going to go out of business. But it's important to spread your money around if anything, I would use ETFs that get into regional banking.

Jason Moser: Yeah.

Matt Frankel: There are some good ones, the KREs, the iShares Regional Banking ETF. There are a few good options that can spread your money around. If we're not at the end of this crisis yet, and maybe there's another one or two banks to fail, you're not going to get crushed. But it does feel like a feeding frenzy and the regional banking space in the past week or two.

Jason Moser: Yeah. It really does. It's just amazing to see. I mean, the steps that regulators take to instill more confidence in the system and make everybody feel a little bit better. It's like it all has the opposite intended effect. It makes people panic even more, they pull their money out of these regional banks even more quickly they put into the big banks. I mean, at the end, I don't know how many people are really running. Multiple $250,000 plus deposit accounts. It's always worth remembering that FDIC insurance applies whether you're at a big bank, at a regional bank, at a small bank, correct?

Matt Frankel: Well, generally speaking, whenever an investor has told not to paddock, that's exactly what they probably should be panicking.

Jason Moser: Now I don't want you to worry metric, but I have some news.

Matt Frankel: Well, this is what led to the SVB issue in the first place. It wasn't a bank run until the bank told investors not to panic. Where do we need to raise capital, but we're OK. What did it investors do? They panicked.

Jason Moser: Of course.

Matt Frankel: You're right, there are different w4orlds when it comes to banking. There's the regionals, there's the big banks which are completely fine. They're too big to fail. We've been told her too big to fail and they have a lot more regulatory oversight, which is a big difference. Which under the old too big to fail threshold, SVB would've been in there.

Jason Moser: Yeah.

Matt Frankel: But that was raised 250 billion of assets. SVB was around 200. They weren't considered a big bank, even though they weren't pretty big bank.

Jason Moser: Yeah.

Matt Frankel: There are a few different worlds and banking and regional banks are in a strange spot that they have a lot of money deposited with them, but are under the threshold where they're really put under a microscope.

Jason Moser: Yeah. Well, speaking of the bigger banks and it, let's talk for a minute about one of those bigger banks, I guess it is. I mean Schwab. I think it's an aim. Probably most of us are familiar with either through commercials or the fact that we have some form of account with them. But Schwab is a $100 billion market cap in this bank has gotten crushed during this mess. I mean, it's down 35% year-to-date. That seems a little bit of an overreaction. Why do you think Schwab is getting hit so hard?

Matt Frankel: But a lot of people don't even think at Schwab is a bank. It's thought of as a brokerage.

Jason Moser: Yeah.

Matt Frankel: But they do have bank accounts. They have a pretty big banking platform. The negatives are just like SVB; Schwab has a lot of unrealized losses and it's held to maturity portfolio like most big banks do right now. About 29 billion in Schwab's case, their retail deposit bank has 7 trillion in client assets and a number like that, there's a lot that can go wrong. One of the biggest concerns that I think people were missing it first, it's not that Schwab is going to have to have a big run on its bank or anything like that, or it's going to have to sell assets. It's that we could see a lot of retail customers start to exit its bank because of interest rate concerns.

Because Schwab's bank accounts don't pay the three or 4% yields you get from a lot of high-yield savings. Platform save 0.45% right now and they're in the Schwab banking platform. There is a worry that not only could there be a bank run because of this, but because investors can savers wants a more yield but positive seem to outweigh the negatives here. Schwab is a well-capitalized institution. Very little risk of having to sell that held to maturity portfolio. Most of its deposits are insured, 80%, unlike SVB were, 5% were insured and it hasn't seen customers leaving it, seeing people move money around, maybe from a savings account into say, treasuries, but it's not seeing customers leave.

Jason Moser: Well, what about some of the more beaten-down banks that are still pretty well insulated from all of this beyond just these bigger institutions like a Schwab or the too big to fail. I mean, there are smaller banks that are managing their way through this. They're not in any trouble at all. Now I mean, given their size, I think maybe there's some babies, they get thrown out with the bathwater here, so to speak. But what are some of the banks, smaller banks here that you feel like you're pretty well insulated from all this. Even their share price is today, don't necessarily indicate that, right?

Matt Frankel: I'm glad you mentioned that the share price is stone indicate that because I bought three banks in the past couple of weeks, I added to Bank of America, that's the big one. It's really rare. You can get Bank of America for less than book value these days right now, yes. It's like you said, throw the baby out with the bathwater. That one's doing just fine. But the two smaller ones I bought our what is SoFi, which I've talked about a few times on shows we've done.

Jason Moser: Sure.

Matt Frankel: Listened to some of these numbers. The median bank has 30% of their Tier-1 capital unrealized losses, 30%, SoFi is 0.26%. Their loan portfolio has not declined in value because they've short maturity loads like student loans, they have personal loads, not 30-year treasuries that are based on a lot of time value?

Jason Moser: Yeah.

Matt Frankel: Uninsured deposits. The median bank, we don't I said SVB had 95%. The median bank has 60% of their deposits uninsured. SoFi is about 8%. They just rolled out a new technology that allows up to two million dollars of FDIC insurance by effectively spreading consumers money out the partner banks, taking advantage of that to 250,000 per bank limit. SoFi was number 2. Number 3 is Ally Financial, AOI. Now, this is not a low-risk bank stock, but it's well insulated from the current situation. Most of its banking customers are smaller retail customers. Its loan portfolio is mostly short duration, so not getting hit by these held-to-maturity issues, it's an auto lender primarily. The biggest concern is a rise in default. Not the need to necessarily sell its assets at a loss, but that people are going to have trouble paying their auto loans back, which is a real concern.

Jason Moser: Understand well, yeah.

Matt Frankel: But the banks doing a great job of preparing for it. The allied currently has roughly double its current delinquency rate sitting in reserves, preparing for the spike in defaults. It's doing a good job of preparing for it. Like I said, it's well insulated from what's going on right now. Those are three I've bought recently, Bank of America, SoFi an Ally.

Jason Moser: Very nice. Well, let's leave our listeners here with something actionable because I love what you are seeing there with those repurchases you've recently made. I know you follow this space very closely and we've been able to talk about it for years together. You certainly taught me a lot of the process. I think you have plenty to offer your what. What is something that we want to give our listeners something they can incorporate into their investing toolbox here to make them better investors. If you're interested in investing in banks, what are some of the things to follow metrics that matter, I guess is what I would call them. What do you feel like the metrics that matter most for investing in banks are today?

Matt Frankel: Will look for a discount to book value. But take that with a big grain assault. As I mentioned, a lot of assets are worth a lot less than banks paid for them. The best metrics to look at right now are, like I said, discount to book loan growth. Whether you are seeing inflows or outflows, that's a big one. You mentioned the big banks. We're seeing a lot of inflows right now. You want to see that outflows have been manageable at some of these regional institutions. If that's what you're going to get into. If you're seeing a lot of investors head for the exit out investors, depositors, you'll see these institutions announced a need to raise capital.

Not necessarily to the point like SVB did. But you'll see him say, OK, we need to tap the Fed's discount window a little bit more. We need to raise capital from larger banks. We need to do things like that. That can be a little red flag that maybe you want to sit on the sidelines for a little bit. We saw a few of the business focused banks in the regional space after the SVB thing. I personally look for lower exposure to business banking in more exposure to personal banking, because those are the accounts that have a lot of insurance. Those are, people tend to not like to switch their banks very much.

Jason Moser: Yeah.

Matt Frankel: That'd be lesser as I serious issue. I look for less exposure to business banking myself, but that's just me the big discounts to book value of the sector. I know that's really what I'm looking for.

Jason Moser: Matts of great ideas. Some great things to look out for in the space. Really appreciate you taking the time to join us today. Thank so much.

Matt Frankel: Thanks for having me.

Chris Hill: As always, people on the program may have interest in the stocks they talk about. The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.