Stocks and Shares

Stock alert: hell-fire or hell yes?

In England in the 1740s a fellow called Sir Francis Dashwood set up something that became known as the “Hell-Fire Club”. Its purpose? Drinking and fornicating by “persons of quality”, themselves often involved in politics. What’s that got to do with stocks? Not a lot. But perhaps it tells us something about politics.

Also today, as promised, an update on Deutsche Bank stock. It’s a massive investment bank that has a lot of people worried, but could offer huge profits for intrepid investors. But first, let’s get back to that Hell-Fire Club…

Benjamin Franklin, of US “founding father” fame, is said to have occasionally attended Dashwood’s Hell-Fire club meetings in 1758, when he spent some time in England. Some historians claim this was only as a spy. Hmm…Ben Franklin undercover whilst under the covers…and under the influence.

Perhaps Franklin’s experiences helped convince him that the colonies in North America should seek independence from decadent British rule. Or at least that if a bunch of immoral drunkards could run an entire global empire, then surely almost anyone could run a narrow strip of land on the east coast of North America.

But I digress. And why am I talking about Sir Francis Dashwood and his wild parties in the first place? Well, yesterday I took my Dad (aged 80) to an old manor house called Grey’s Court that nestles in the rolling green hills of Oxfordshire, England. There we met up with his surviving sister (aged 89), her son (my cousin) and grandson. A day out in a fine spot, and a chance for two senior siblings to spend some rare time together.

The place has a known history dating back to 1086, when it popped up in the Domesday Book – a sort of giant wealth census. Not much of the original house or its fortifications survive. Most of what’s still standing was built “only” 400 to 600 years ago.

Greys Court has had some important and distinguished inhabitants, with close links to various monarchs over the centuries. But one owner, Sir Thomas Stapleton (1727-1781), has a less honourable claim to fame. He was Dashwood’s cousin and a hell raising member of the exclusive Hell-Fire club. Oh, the parties they must have had.

Dashwood himself eventually ended the Hell-Fire meetings. It was around the time he was made Chancellor of the Exchequer (British finance minister) in 1762.

Imagine making that transition in the world’s most powerful nation with today’s media on your case! It would be like Hugh Heffner, of Playboy mansion fame, taking over from Jack Lew as US Secretary of the Treasury.

In any case, Dashwood didn’t last long in that role. After imposing a tax on cider – which nearly provoked mass riots – he had to leave the post.

If nothing else the episode proves that politics and double standards are not new bedfellows. Dashwood was happy to imbibe vast amounts of wine with his posh and raucous friends, but just as happy to tax the cider ingested by the poor. No taxation without fermentation!

Jumping to the sober present, I owe you an update on a huge global investment bank with its headquarters in Germany, Deutsche Bank (XETRA:DBK / NYSE:DB). It’s priced for destruction, meaning stock investors will either lose a tonne of money if the market is right, or clean up nicely as it recovers in coming years. (See my earlier analysis of the situation here and here.)

If he achieves what he’s aiming at then in four years’ time the stock will be worth about three times as much as its market price today.

Long story short, Deutsche Bank is a turnaround story, not a growth play. It’s newish CEO John Cryan is one of the best in the business. If he achieves what he’s aiming at then in four years’ time the stock will be worth about three times as much as its market price today.

When I wrote about Deutsche before, a few weeks ago, I reckoned it was worth waiting until second quarter results came out before taking an investment position. Either an early profit warning or the results themselves would alert us to any major problems.

Those results came out two days ago. There was no profit in the second quarter. Revenues were pretty weak in most businesses. But none of that short term stuff matters for our purposes.

The crucial point is that there were no multi-billion dollar (or euro) asset write downs. No crisis. No announcement of a big capital shortfall. No imminent dilution of existing shareholders.

Message to market from Deutsche Bank: we’ve still got lots to do with our turnaround, markets are a bit tough at the moment, but we’re more or less on track and doing fine.

As I write the stock is priced at 11.81 euros (and US$13.89 in New York). That means it’s worth just 0.32 times the tangible book value per share at the end of June (see the earlier articles for further explanation).

Put another way, in theory you could buy and liquidate Deutsche Bank and get more than three times your money back. And, as I explained before, if Cryan achieves his targets then this stock will rocket over the next few years – even if the ride could be bumpy.

There are two caveats. The first is that the European Banking Authority (EBA), in coordination with the European Central Bank (ECB), is due imminently to report results of stress tests for European banks, late on Friday 29th July after markets are closed.

These tests are supposed to tell us whether important banks across Europe – including Deutsche – have enough capital to withstand severe market shocks. Best to wait and see what they say.

Also it’s worth noting that Deutsche Bank remains quite highly leveraged. Tangible assets are more than 34 times tangible common equity. (“Tangible” means excluding goodwill, and is also explained in the earlier articles.)

That’s a lot less leverage than it had at the end of 2006, before the global financial crisis. Back then the bank was 60 times leveraged. Swiss competitor UBS – my old shop – was even worse, and over 68 times leveraged on this measure. But UBS’s subsequent near-death experience meant it brought that number way down to 20 times by the end of 2015 – making it much less risky than before.

Using consistent accounting rules, that makes UBS’s leverage similar to JPMorgan Chase’s 18 times and Goldman Sachs’s 22 times – two big US competitors. (American and European banks use different accounting rules for financial derivatives. That makes US banks look a lot less leveraged, until you make the necessary adjustments.)

Deutsche Bank still has a lot of work to do in terms of getting its assets down or its capital up. But it seems to be on track, now that it has capable management with a clear idea of what’s needed.

In other words, back in Frankfurt, Deutsche Bank still has a lot of work to do in terms of getting its assets down or its capital up. But it seems to be on track, now that it has capable management with a clear idea of what’s needed.

So when it comes to Deutsche Bank stock is it hell-fire or hell yes? I’d say it’s much more likely to make you a lot of money – on a three to five year view – than it is to lose you money.

If this bank doesn’t fail the EBA stress tests then I suggest you take a modest position next week. Then try to forget about it until at least 2019, unless you hear that CEO John Cryan has been kicked out.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.

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