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The twin attractions of buying on equal terms with insiders and the favorable arithmetic of a thrift conversion make for a compelling investment opportunity as long as the preconver-sion thrift has a positive value. Many thrifts, of course, are worth less than their stated book value, and some are insolvent. Funds raised on the conversion of such institutions would pay to resolve preexisting problems rather than add to preexisting value.
Investing in Thrift Conversions 195 Why were thrift stocks so depressed in the 1980s? The sell side of Wall Street has historically employed few thrift analysts, and the buy side even fewer. The handful of sell-side analysts on duty typically followed only the ten or twenty largest public thrifts, primarily those based in California and New York. No major Wall Street house was able to get a handle on all of the many hundreds of converted thrifts, and few institutional investors even made the effort. As a result, shares in new thrift conversions were frequently issued at an appreciable discount to the valuation multiples of other publicly traded thrifts in order to get investors to notice and buy them. Of course, fundamental investment analysis applies to thrifts as it would to other businesses. Thrifts incurring high risks, such as expanding into exotic areas of lending or venturing far from home, should simply be avoided as unanalyzable. Thrifts speculating in newfangled instruments such as junk bonds or complex mortgage securities (those based on interest or principal only, for example) should be shunned for the same reason. A simple rule applies: if you don't quickly comprehend what a company is doing, then management probably doesn't either. This initial test limits investors to low-risk thrifts. This does not mean that investors could not profit from investing in risky institutions but rather that the potential return is not usually justified by the risk and uncertainty. Owing to the high degree of financial leverage involved in thrifts, there can be no margin of safety from investing in the shares of thinly capitalized financial institutions that own esoteric or risky assets. While all businesses should be valued conservatively, conservatism is even more important in the case of highly leveraged financial institutions where operating risks are magnified by the capital structure. In evaluating such thrifts, book value is usually a low estimate of private-market value; most thrift takeovers occur at a premium to book value. Investors should adjust book value upward, however, to reflect understated assets, such as appreciated investment securities, below-market leases, real estate carried below current worth, and the value of a stable, low-cost deposit base. Similarly book value should be
196 THE VALUE-INVESTMENT PROCESS adjusted downward to reflect balance sheet intangibles, bad loans, and investments worth less than cost.