Category: Investing

Why I Sold Bank of Internet (BOFI)

Why I Sold Bank of Internet (BOFI)

Selling a stock is often the hardest decision but BOFI has been a real lesson in my purchase decisions and diligence levels – I should never have bought it. After much soul searching, I discovered that I was misled by my own idealisms of the bank. I wanted it to be something it’s not and actually, I now think Bank of Internet could be in real trouble in the medium term.

Image result for bofi logo

Sound initial investment thesis

BOFI provides consumer banking services, focusing on gathering retail deposits over the Internet and originating and purchasing multifamily, single-family and home equity mortgage loans and, more recently, vehicle loans.

Because of its online-only business model (which I do believe is the future of banking) it earns high returns on its assets (ROA) in the region of 1.65%. The St. Louis Federal Reserve provides data on US bank ROAs, which, since the data started in 1984, have generally hovered around or just above 1%. A small increase in the ROA of a bank can drive large increases in Returns on Equity. 1.65% is extraordinary.

All of the above coupled with the fact that it’s a relatively small bank with a fast-growing asset base meant that I saw it as an undervalued and underappreciated asset. My formula was quite simple – greater efficiencies means BOFI offers higher interest rates to customers which results in increased deposits and more loan underwriting which drives higher profits.

After doing my usual quantitative analysis I decided to invest.

Re-evaluating BOFI with new tools

By not constantly checking and testing your investment thesis then mistakes will eventually erode your returns. Recently, I’ve been applying a new qualitative lens to evaluate my stock holdings – cutting through opacity.

Nassim Taleb’s book, Antifragile, really drove my desire to re-assess BOFI. It states that it’s important to derive as much comfort as possible when confronted with opaque industries.

Banking is certainly one of the opaquest and it, rather unfortunately, entices greed and short-term thinking. A respected institute such as Wells Fargo has created the latest scandal, and this harks back to the 80’s when Solomon Brothers created a similar humiliation for Buffett.

Taleb claims that no one is more aware of the risks around a company than the people who build it. They are as invested in the success of the company as you are – if anything they are more exposed, so it pays to listen to their criticism.

There is also another and more important stakeholder to asses in my opinion – the customer. Disgruntled employees but a great product means that management is poor, this could be rectified with time. Both employees and customers viewing the firm negatively is a definite cause for concern.

Honest stakeholder reviews

Let’s go ahead and look at both stakeholder’s opinions.

Here are some of the google customer reviews below. It’s surprising that they have received only 2 stars overall. Read them all here.

“By far the most miserable banking experience I have ever had in my life. The online banking UI is a complete nightmare. Ironic, because B of I advertise itself has being entirely online without the hassle of needing to go in-person for your banking needs. It takes the team literally months to resolve any issue–and there are issues aplenty, because, again, the online platform is practically useless. Save yourself a major headache and go with a competent bank.”

“This bank is tanking fast. Imagine calling a bank of this magnitude’s technical support line because of a glitch in their online banking. The phone rings, rings, rings, about ten minutes later, voicemail. Try it again, same thing.”

“The online banking access is horrible. If you don’t log in every 90 days you can’t access your account and calling customer service is an exercise in futility.”

It was certainly a sobering development to my personal conception of BOFI. I then decided to read some of the Glassdoor reviews by employees here where it holds 2.7 stars out of 5 overall – this hasn’t changed since 2015.

“New company that doesn’t have everything in order to run as a successful business. No policies or procedures so there was a lot of risk for errors and usually no accountability. Two years since I left so everything could be getting better but if the same management is in place I seriously doubt it.”

“For an internet bank that has been in business 17 years, it is odd that it is not current with the times; astounding really. A lot of things are shrugged off instead of acted upon.”

Whilst the CEO and annual reports may gloss over and even ignore these issues – there is no papering over the cracks of honest online reviews. It’s like the clouds of opacity were lifted and I saw the real beast below.

Idealism vs Realism

Motley Fool compared BOFI with other banks as follows: “One’s a 21st century online-only lender. The other’s a classic bricks-and-mortar incumbent”. Well, perhaps I was the fool in building my investment thesis off the back of that hugely simplistic contrast. The narrative I had created in my mind was a fallacy. I ignored the cold hard facts and was sold on an ideal.

The cold hard facts, in my humble opinion, are that BOFI’s incredible ratios are driven by its lack of investment in its technology, platform and customer service department. Efficiency ratios are certainly going to be high if you are not investing or expending but how long can that kind of business last? It seems counterintuitive then, that a bank named Bank of Internet is apparently more archaic than some of the incumbents.

Past returns are no guarantee of future returns

BOFI’s business model is currently in the Goldilocks zone and that’s been the main driver of its +1500% growth in share price since 2007. It is offering customers deposit rates that are slightly higher than competitor’s rates and, in today’s low interest rate environment, I believe that this is the reason assets have been growing at a rapid pace.

These deposits are then being lent as mortgage loans at high yields. If interest rates normalize and people become less obsessed over the competitive marginal yield spreads which BOFI offers, then asset growth could slow and perhaps even evaporate. Furthermore profits will be pressured by borrowers who might find it more difficult to pay back the high interest rate loans.

Whilst I could be wrong, many alarm bells are ringing over BOFI. This has been a highly valuable lesson for me and luckily a relatively inexpensive one.

See my other investment tips here.

Book influences:

Disclosure: I hold no position in BOFI and don’t intend to open one.

Stock of the moment – North Midland Construction The Turnaround

Stock of the moment – North Midland Construction The Turnaround

Stock of the moment – North Midland Construction

NMD: North Midland Construction current stock price: £4.08. Intrinsic value: £7.20. Margin of safety: 76%

The key to a successful turnaround

Peter Lynch said :

“Bottom fishing is a popular investor pastime, but it’s usually the fisherman who gets hooked. Trying to catch the bottom on a falling stock is like trying to catch a falling knife. It’s normally a good idea to wait until the knife hits the ground and sticks, then vibrates for a while and settles down before you try to grab it.”

Image result for north midland construction logo

Who is North Midland Construction?

North Midland Construction is a civil engineering firm which operates nationally with twelve strategically located regional offices and workshops. They have six operational divisions which provide focused services to customers across five chosen core market sectors: Construction, Power, Highways, Telecommunications and Water.

Legacy costs will disappear

Their results have been turbulent of recent years due to mispricing of legacy contracts which have been incurring heavy losses. Legacy contracts are construction contracts entered into at the height of the recession which carried a high contractual and commercial risk. These contracts have impacted the Group’s income statement in 2013 and subsequent years. Last year the total loss before tax recognised on legacy contracts was £3.85 million which left £2.6m total profit overall.

Last year the group completed all on site works for the one remaining legacy contract, therefore removing any further uncertainty around costs to fulfil the contract. If we know that there will be no legacy hits this year, then we know that all NMD has to do is equal last years adjusted performance to double earnings per share.

The turnaround questions

While looking for investing in potential turnarounds, some points to be considered are:

How much cash and debt does the company have?

NMD has a 0.31 debt to equity ratio with £11m in the bank as of last year. This suits me well however the biggest risk I see with NMD lies in its current ratio which sits just shy of 1. The current ratio is a liquidity ratio that measures a company’s ability to pay short-term and long-term obligations. NMD technically can’t quite do that.

What is the company’s strategy?

The company had a huge shake up mid 2016 with the appointment of a new CEO, John Homer. John was previously with Morgan Sindall and had also worked at Galliford Try. This gives NMD two big green ticks in my box as these companies have delivered tremendous shareholder value. He’s also a self-proclaimed maths nerd which is another big green tick.

Following last year’s major upheaval to address the bottom line, Mr Homer is leading the group towards achieving an ambitious target of a 5 per cent operating margin within five years on top of £500m revenues. That represents a doubling of the business with a much healthier margin than today. Generally you don’t come out saying things like that a week before interims unless you know that you won’t look silly.

Will this make a big difference in earnings?

Well the above plan would give shareholders an EPS of £2.50 in FY22. (Oh that’s another beautiful aspect of this company – it has 10 million shares outstanding so per share calculus is exceptionally simple). The short-term key to this trade is the knowledge that when we add-back this final legacy loss to FY16 then net profits would have been at least £5m last year – essentially doubling earnings per share from 26p to over 50p. 15 x earnings on 50p = £7.50 per share. This means that earnings should double before the above margin improvements are even implemented giving a substantial margin of safety.

Is business coming back?

Business has always been growing It’s simply a case of poor commercial decisions on big contracts which didn’t properly account for risk. Quite a dangerous game with the wafer thin margins in construction. In fact, they have recently won a new joint venture infrastructure contract for Severn Trent Water worth in excess of £100m. North Midland Construction has also been shortlisted for a portion of the £1 billion YORcivil2 project.

The company will release interim results on 10th August 2017 which will provide us with further insight here.

The answers for these questions for NMD are very positive indeed.

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The fundamentals

The above contract wins lead me to believe that revenue growth will continue to at 15-25% per year. If this is the case and net margins achieve 2% (fairly likely given the legacy costs are disappearing) then we are looking at a Net Profit of £5.75 million this year. Across 10 million shares that gives a forward earnings per share of 58 pence. Even by the BREXIT battered construction sector’s standards (an opportunity for us contrarians) it makes the share exceptionally cheap at 7 x earnings. The construction industry’s average forward PE is 16 x earnings so comfortably below its peers. At 15 x forward earnings the shares should be worth £8.70.

So what return can you comfortably expect on this? long-term holders at these prices can expect a return of 14.28% per year (1 divided by a P/E of 7 equates to 14%).  That return comfortably covers the risk of holding NMD.

DCF says yes!

The other valuation metric I use is a discounted cash flow. Lets assume that the average cash flow for the last three years continues at a comfortable £5 million (I expect it will be more but let’s be conservative).

I capped the growth rate at 10% per year for ten years (again very conservative). I set a discount/required rate of return of 14% on future cash flows which provides £36 million in future discounted cash flows. Then I add the perpetuity rate of 2% giving me a further £10 million cash flow into perpetuity. Let’s not forget the cash in bank of £11 million. In total this equates to an EV of £57 million. £5.70 per share for those of you who haven’t got your abacus beside you. That’s 38% upside from today’s price and an inbuilt return of 14% per year.

 money cheers startup hustle startups GIF

The market

I tend not to focus on the market but it’s necessary for cyclical companies such as NMD. The market is certainly pricing in a correction on many construction firms and who can blame them? We have been riding this bull for quite some time and BREXIT did knock us somewhat.

Despite the headwinds facing the UK overall, my overarching theory is that if another correction came then the government has no other option than to revert back to classic Keynesian economics and therefore it may invest heavily in infrastructure. This bodes well for NMD in the long-term. If a correction doesn’t come, well this also bodes well for NMD. I’m not talking about the share price here – I’m talking solid shareholder returns.

My first turnaround

Overall I’m pretty happy to dip my toes into this turnaround. Taking the forward EPS and DCF gives me an intrinsic value of £7.20. The short-term earnings boost now that the legacy contracts have disappeared will build my margin of safety. The general low price relative to earnings potential will continue to be a catalyst to the share price over time. I can quite easily see this being £37 in 5 years if John’s vision comes into fruition.

The one key risk area that I will be keeping an eye on is the current ratio and NMD’s liquidity. If a contraction did occur and our short-term assets couldn’t cover short-term liabilities then money will need to sourced from somewhere. I’m sure that this is an area that John will be addressing.

As per Peter Lynch’s quote – the knife has hit the ground, stuck, vibrated for a while and now settled down so I’m ready to grab it. The upside for North Midland Construction more than compensates for the downside.

Find my other stock tips here.

Book influences:

Disclosure: Long North Midland Construction

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FY17 Personal Investment Fund Return +27%

FY17 Personal Investment Fund Return +27%

Stocks & Shares ISA Fund

I opened my investment ISA fund in July 2016 so it makes sense to review my performance objectively, analyse my trades and reflect on my decisions.

The fund enjoyed a CAGR of 27%.

Just to put things into perspective, it’d take about 17 years to grow £10,000 into £1 million at that kind of growth rate. Quite motivating when you think about it like that.

Ignore the media narrative

My first investments were Apple, Berkshire Hathaway, Goldman Sachs and General Motors in July 2016. Pretty concentrated on the USA you may think. Well this opening ensemble had greater strategic depth which still plays a role in my allocation of capital today. Firstly, and you may have forgotten already, the US was unloved last year – the media thought that the US would collapse if Trump became president.

I did not predict the trump rally, however, I did think investors were missing a trick by avoiding US equities. Secondly, my goal was to convert my GBP savings into USD earnings due to BREXIT. I entered my positions around GBP/USD $1.33 expecting a drop to circa $1.20. I reaped my reward with that speculation.

Sell at fair value

I implemented and maintained my value based investment strategy this year and haven’t diverged. Apple had become seriously undervalued so I started buying Apple before Buffett announced he was snapping it up (that was quite the compliment by the way, Mr Buffett). I calculated intrinsic value between $125-$146 back then. The media were bashing Apple and comparing them to Blackberry or Nokia but as I noted here, google trends showed otherwise. It’s the only company I have retained out of the four.

US banks were the least loved out of all US equites so, unphased, I purchased Goldman Sachs. I bought at $160 and sold at my estimated fair value of $227. This provided a 51% return, dividends and currency gains included. I sold before the peak but the chart below shows that it has hovered around fair value since March. I wasn’t expecting a fair return so quickly, I was actually hedging against interest rates. It has pleased me that I am able to make the difficult sell decisions. I haven’t been carried away in the market stampedes yet.

Goldman Sachs 2 Year share Price fund
Goldman Sachs 2 Year share Price – ISA FUND

Find a Gem or two

I discovered Taptica just as my US investments reached fair value in February. You can read all about that opportunity here. My conviction led me to sell my US positions and load up on Taptica. Taptica generates it’s earnings in USD so it also maintains my bearish position against UK plc.

I was anticipating a very strong earnings rally. It paid off and returned 30% in seven days. I then halved my position in Taptica and invested a portion into payment processor Paysafe (recently sold after the Blackstone takeover offer for a 25% gain).

I continue to hold Taptica despite it reaching fair value based on last years results. It’s hard to justify selling because of its growth potential and shareholder friendly management team. The shares have increased 100% since I entered at £2.00. This allows me some wiggle room if things turn sour.

Value stocks don’t always go up

I had been lucky that everything I’d invested in showed positive price action as soon as I entered. This lulled me into a false sense of security and so I invested in Hurricane at its high. I wrote about Hurricane here.

Retrospectively it was silly move. The national news plastered Hurricane in all corners of the UK. My dad actually mentioned it in passing – I should have known better. It had become inflated to the point that management needed to destroy shareholder value to gain the EPS funding.

Luckily I saw this as a risky speculation from the beginning and I only invested 6% of my fund into this. I’m down 37% on Hurricane but I still believe in it’s valuation and management have significantly de-risked the proposition by retaining 100% ownership. I’ve since picked a few more shares up at 31p. I continue to hold knowing that I could double my money or lose it all.

Value > Diversification

Value is presently a difficult thing to locate in the large cap universe so I continue to hold small/medium caps with exception to Apple. There are many companies which I would certainly purchase at the right price but I will not diversify to the detriment of value. Time is on my side to diversify into larger and more stable companies in future.

I have therefore invested in exciting opportunities which include North Midland Construction, a turnaround opportunity, BOFI and Softbank (speculation). I will write about these companies in separate posts in future.

Going forward

My portfolio is trading at a circa 50% discount to fair value which gives me a large margin of safety. Risks are building around interest rate rises and general credit levels in the UK but stocks remain competitive.

In February Buffet said “Measured against interest rates, stocks actually are on the cheap side compared to historic valuations”. I tend to agree. Everyone is falsely focusing on the record Shiller PE ratio which doesn’t take this key component of investor returns into consideration. If anything, the environment is ripe for a melt up where markets rally to levels of excess.

Either way, it’s been a fruitful and educational year.

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Undervalued stocks can still lose 70%

Undervalued stocks can still lose 70%

My portfolio consists of many undervalued stocks which I could argue were worth at least double their current prices. Despite this, I always wondered how they might fare in a 1929 type crash.

If you hadn’t guessed by now, I’m a value investor. Why? It’s a time-tested strategy and it has made people from Graham and Doddsville an awful lot of money. Its methodology is intelligent and based on fundamental business analysis. I urge all Money Generation XYZ readers to follow this system of investing and ignore everything else. Forget binary trading, overlook Fibonacci retracements and don’t time the market. Just focus on companies with fortress-like balance sheets, strong historical earnings and a durable economic moat trading at a discount to fair value.

Discover whether you are an investor or a speculator, here.

Undervalued stocks during a crash

To see how value investing performed during 1929 I had to turn to the old testament of value investing: Benjamin Graham’s and David Dodd’s Security Analysis. Here’s a window into the life of a value investor in 1929.


Graham was convinced that, because his stocks were worth less than the cash on the companies’ balance sheets, he couldn’t be harmed by the impending crash which he foresaw. So much so, that he used leverage to amplify his potential returns. In 1929 Graham lost 20% of his partnership’s capital – pretty impressive all things considered – another 50% in 1930, 16% in 1931 and 3% in 1932. A cumulative loss of roughly 70%.

“I blamed myself not so much for my failure to protect myself against the disaster I had been predicting, as for having slipped into an extravagant way of life which I hadn’t the temperament or capacity to enjoy. I quickly convinced myself that the true key to material happiness lay in a modest standard of living which could be achieved with little difficulty under almost all economic conditions.”

– Benjamin Graham.

There are tons of lessons here. It certainly shows that a large margin of safety cannot protect against a crash. Here are a few tips to counter the mistakes that Benjamin made back in 1929.

 Live within your means

Ask yourself, if my portfolio dropped by 70% tomorrow then I would I care? I wouldn’t. I’m still entitled to the same earnings as before and my ownership of the company hasn’t changed. I am mentally and financially well placed to cope with such market extremities but they will certainly be testing times if you aren’t.

Before you invest, set aside capital to cover between 3-6 months of bills in the event that you lose your job. For me, this buffer is £3,600. This sounds like a lot now but as you grow your net worth it’ll be a smaller proportion. Save like a pro and you’ll have that money in no time. Try not to buy a car on finance either, it’s a sure-fire way to erode your potential savings and adds an extra layer of risk to your situation.

 Never use leverage

Leverage no doubt amplified Graham’s losses. Debt masquerades itself as the answer to bountiful returns when times are good and reveals itself as the devil in disguise when times turn bad. Times will always turn bad. Investing on a margin will drive you to make really irrational investment decisions. See what Warren Buffett says about leverage here. If you want no assets, then leverage up baby!

Warren Buffett leverage quote

Materialism isn’t the answer to happiness

Buying that car on finance, that expensive watch or that big house with a 5% deposit is fine but it will offer very little satisfaction in the long run. When things go belly up they will cause a strain on the important things in life such as your relationships and mental well-being.

Money can certainly play a role in happiness and stop a poor standard of living but there is a threshold according to behavioral economists. Focus on living comfortably and drawing happiness from the people and the world around you.

Collect moments not things - materialism

Don’t time the market, position yourself

Look, what’s the point in standing on the side-lines of the market in the case of a crash? One day you will be right but you would have been wrong every day for the last 10 years. Graham predicted a market crash but he did not protect his portfolio or his personal finances. That’s where he went wrong. A crash may destroy the value of your portfolio regardless of whether it’s undervalued or not.

To be fair to Graham, he didn’t know that his undervalued stocks would crash just as hard as everything else. He had an excuse – we don’t…

Ned stark meme "brace yourself"

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