Saturday, September 23, 2006

Learning from Past Mistakes

I have a mistake that I hope none of us repeat. I invested in W Holding(WHI), a puerto rican bank, a little over a year ago on the belief it was chief. My reasoning was this. The company had a long history of making good returns on equity. It continued to gain market share in its home market, and it was even planning on starting expansion into the US. It had a CEO with a stake in the company and it had a history of never being unprofitable. Plus, it was trading under 10 times earnings.( An analysts estimate of earnings)

So What went wrong? Well, alot of things. For one, i ignored a lot of important factors that must be analyzed for a bank. These factors led to a steep drop off in the earnings/earnings potential of the company. I now understand some of these, though I havent invested in a bank since this incidence. One, WHI was able to grow their market share so fast because they were being very agressive in acquiring funds. A majority of their deposits were high-yielding, something I failed to consider. Whereas some banking institutions, such as Wells Fargo, have a huge supply of virtually costless deposits in the form of checking accounts, WHI was only able to attract all the money it got through its costly savings accounts and preferred shares. The second factor I didnt take into account was the difference between interest and non-interest income. This factor, when combined with the first, can lead to a deadly combination. A bank can only control so much when it comes to their interest spread and profitability. But non-interest income is usally recurring, safer, and far more desirable. Certain banks, again such as Wells Fargo, have a very high percentage of non interest revenue (approx 40%). WHI had under 10%. The result of all this is recent history. As the yield curve flattened, WHIs cost of funds increased while the yields on its loans decreased. It also began to take increased charges for loan due to an increase in bankruptcy filings in puerto rico. (This was another mistake.. the market and economy of the bank's constituency is also very important).

Two dreadful earnings reports and a 20% loss later, I cut my losses and realized there was a lot about the banking industry that was at the time outside my comprehension. The above factors are VERY important to consider when buying a finanial institution, and they probably illustrate two reasons why Buffett continues to add to his Wells Fargo investment.

For a read through several other mistakes, visit the link below.

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