Riskiest Financial Stocks Have Lowest Cost of Capital
So much for investors being compensated for risk.
Just to set the stage, the economic sector with the lowest WACC in April 2008, just after JPMorgan Chase (JPM) executed its shotgun wedding with Bear Stearns, was the financials. Within the financial sector itself, the lowest WACCs belonged to the group called "other diversified financial services," an interesting name for mega-banks such as Bank of America (BAC) and Citigroup (C). Other groups with low WACCs within the financial sector were investment banks and brokerages, which then still included Merrill Lynch and Lehman Brothers along with Goldman Sachs (GS) and Morgan Stanley (MS), and thrifts & mortgages, which included Fannie Mae and Freddie Mac.
Three and one-half years later, what have we learned? (Hint: Why would I be asking this question if the answer was not, "Nothing"?) At present, both the utility and telecommunications sector have below-average WACCs less than the financials, but financials are still the third-lowest.
Now comes the real knee-slapper: Within the financial sector, the lowest WACCs still belong to the same groups even though their herd has been culled.
I can conclude one of two things here. The first is investors en masse crave financial leverage and are willing to fund it cheaply. The second is the huge presence still of government price supports, subsidies and free put options of one sort or another make these financial stocks far less risky than they might seem on the surface.
I am going to go with the former as the financial sector and these selected groups therein all had below-average WACCS prior to the financial crisis, a time when TARP simply was what the grounds crew put over the infield when it started to rain. Investors should have looked at the business models of these firms then and the fate of previous smarty-pants derivatives traders such as the late Bankers Trust, the late Enron, the late Kidder Peabody and the late Long Term Capital Management, just to name a few, and demanded some serious recompense for the use of their money. They ran funds up to the doorsteps of these banks in wheelbarrows then and continue doing so today.
Financial theory says investors should penalize riskier assets; nutrition theory says McDonald's (MCD) should make more money on spinach salads than on French fries. It will be a shame when financial textbooks go all-digital; at least now they can serve a useful purpose as landfill.
Follow the markets all day every day with a FREE 14 day trial to Buzz & Banter. Over 30 professional traders share their ideas in real-time. Learn more.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter