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Investing in Micro Cap Banks

Investing in Micro Cap Banks

One of the local banks in my area is ENB Financial Corp (ENBP), a $65 million market cap, profitable, micro cap bank.  The stock literally trades 500 shares a day, and the only way you would know it was public is if you were looking for another stock and you accidentally put in the wrong symbol.  I remember way back in 2009 the stock traded 10,000 shares in one day and I thought it was a mistake.  ENB Financial is probably one of a hundred or so micro cap banks that exist, and I’ve always been fascinated by them.  Most are fundamentally sound local banks whose financials barely budged during the 2008-2009 economic crisis. I thought the article below was well written on the topic of micro cap banks.

Written by DoctoRx From The Daily Capitalist: Most of the time, an investment strategy that fights the Fed (or the central authorities writ large) is like spitting into the wind-that is, it’s a bad idea.  They are, after all, TPTB.  This brings me to the Fed’s purpose, namely banking.  The stated rationale for the Federal Reserve Act of 1913 was to make the banking system work better.  This has taken a century’s worth of twists and turns, but anyone who has read The Theory and Practice of Central Banking by one of the architects of the Federal Reserve and who served as its first treasurer, written during FDR’s first term, knows that one constant is that the Fed is joined at one hip with the banking system and at the other with the Treasury Department, but only indirectly affects the economy at large.

This post briefly discusses the other end of the size spectrum from banks that the OWS and Ron Paulites (amongst many others) typically focus on:  small, geographically compact banking companies that were uninvolved in the worst shenanigans of the bubble and post-bubble era and which may have been harmed rather than helped by Fed actions over the past few years.

This may be a time in which banking has seen its nadir both from an operational standpoint and in terms of public image.  Both could hardly be lower.

That combination often spells “opportunity” fin terms of investing in the best operators in any sector.

A year ago, I began investing in microcap bank stocks that had survived the Category 5 Hurricane Lehman of fall 2008.  What I am seeing now is the absence of sellers, improving financial returns in some of the banks and in some cases surging stock prices off of very low levels.  My trading sense is that these are washed-out stocks that we might look back on in 3-8 years the same way we old-timers looked back on oil drilling stocks in 1991 following their disaster in the first half of the 1980s and say- hey, these survivors were cheap, and we continued to need oil all the while.  Why didn’t we buy them (I mentally asked in 1991) when the oil crash of 1981-3 had passed and just waited patiently for the investment worm to turn?

By analogy, the economy continues to function via the Old Normal, with banks as intermediaries for mortgage loans, small business loans, a place to park cash other than under the mattress, etc.  And a survivor of Hurricane Lehman and its aftermath is a survivor, pending of course another major financial hurricane (as opposed to a garden-variety recession).

One good thing about microcap stocks is that small investors have an absolute advantage over institutions; where else can one say that?  Microsoft, PepsiCo, GM- you name a large-cap and you might just be wasting your time studying it.  The big guys know all you know and vastly more than you will ever know about each company- and they know it first.  But truly small cap stocks are too small for them to care about.  With research you can find a number of little bitty bank stocks that did not take TARP money, sell at or well below tangible book value- which the regulators have made them scrub down to conservative numbers- and 2-4+% dividend yields, that you might just be comfortable owning for years on end because they may pay stable to rising dividends and because at the end of the day, their asset values will rise proportionately with inflation and currently may well exceed their stock market valuation.  In fact, what I have found in some of these stocks is that there are very few sellers at current prices.  It may take much higher prices to motivate these shareholders to sell.

Investing in banks is a contrarian thing, the recent surge in stock prices of some of them notwithstanding.  It does not sit well with many individual investors, but most individual banking institutions acted honestly in the run-up to 2008, even if management made mistakes.

Strategically, banks in general prosper when spreads between short-term cost of funds and longer-term interest rates rise (I presume they are all hedged for that eventuality in their investment position), so if one’s financial assets are predominantly in cash and muni bonds, a bank stock might act as a hedge against a rise in rates or rise in price inflation in a cash/bond-heavy portfolio.

The tectonic plates of the Earth are always moving.  The atmosphere is always circulating.  And investment themes are always in motion, as well.

It has often paid for investors to remember that just as summer follows winter, investment sectors that have gone cold often get hot again.

Think different.

About The Daily Capitalist:

The Daily Capitalist comments on economics, politics, and finance  from a free market perspective. We try to present fresh ideas the reader  would not find in contemporary media. We like to call it  “unconventional wisdom.” Our main influences are from the Austrian  School of economics. Among its leading thinkers are Carl Menger, Ludwig  von Mises, Friedrich von Hayek, and Murray Rothbard. There are many  practitioners of this school today and some of their blogs are shown on  the blogroll. We trace our political philosophy back to Edmund Burke,  David Hume, John Locke, and Thomas Jefferson, to name a few.  Our goal is to challenge contemporary economic thinking, mainly from  those who promote Keynesian economics (almost everyone) and those who  rely on statist solutions to problems. We apply Austrian theory  economics to investments, finance, investment risk, and the business  cycle. We have found that our view has been superior in analyzing and  understanding economic and market forces. We don’t consider ourselves  Democrats or Republicans, right wing or left wing. But rather we seek to  promote free markets and political freedom.

The MicroCapClub (mc2) is an exclusive micro cap forum focused on micro cap companies (sub $500m market cap). The MicroCapClub was created and founded by Ian Cassel as a way to share ideas and to learn from other seasoned like-minded micro cap investors. Our goal at MicroCapClub.com is quality membership and quality stock ideas.  If you are an experienced micro cap investor, feel free to Apply today.

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