Financial Stocks: Undervalued, or Value Trap?

Hailed by The New York Times as a "guru to Wall Street's gurus," value investing expert Bruce Greenwald takes some time to offer his insight and advice to The Motley Fool. A professor at Columbia University's Graduate School of Business, Greenwald has also written multiple books, including Value Investing: From Graham to Buffett and Beyond.

In the following video, Greenwald reminds us that, in any given trade, both the buyer and the seller believe they are getting the better deal -- and only one of them can be right. Specializing is the most logical way to make sure you're on the right side of the table more often than not.

Full transcript below.

Matt Koppenheffer: Now, you were talking about different ways to value companies, and you mentioned price-to-tangible book value, which brings me around to ... I spend most of my time working with financial companies. That's a metric that I end up focusing on a lot.

I'm curious if you have been watching the financial sector at all lately, and have any thoughts on ... there are a lot of people, myself included, that think that the sector may be undervalued, but there's also a possibility that that's a value trap with this.

Bruce Greenwald: Oh, come on. No, no. Can I talk about what the big problem with that is?

Koppenheffer: Sure. Yeah.

Greenwald: There is one fact about investing, and it's the most important fact that you can never forget, and there are two ways of saying it.

There's the Lake Wobegon way: The average performance of all managers before fees has to be the average performance of all assets. Now, that's not the same as academic market efficiency, which we know is not true, but if you're going to outperform, somebody else has got to underperform.

I think the best way to think about that operationally is that every time you buy a stock thinking it's going to do well, somebody else is selling it to you thinking it's going to do badly. You have to ask, "What is going to put you on the right side of that transaction?"

What's the most obvious way to do that? It's a way that, to an extraordinary extent, people in finance ignore. The answer is, to be a specialist.

If I've been doing South Texas Gulf Coast onshore oil leases for 20 years and I know the geology and I know the sellers and I know the whole market, and you come down from New York and bid against me for a lease, if you buy that lease, if you win that auction, you've made a bad mistake, because, effectively, in some sense, I sold it to you.

You always are going to do better if you're a specialist. That is especially the case in financial services. A sensible way to value insurance companies is very different from a sensible way to value banks, is very different from a sensible way to value credit card processors, and on and on.

I think if you find yourself doing the shortcut and saying, "Ah, this is cheap because it's low market-to-tangible book," and you apply it across the sector, and the guy on the other side of the trade understands the difference between insurance companies and banks, you're going to get yourself in real trouble. That's the first thing.

On the other hand, when you look for opportunities from a value perspective, you're looking at what's despised and people want to shy away from.

Well, that's a good description of the financial sector, but what I would do is I would say, "OK, the financial sector is a good idea. Who are the best financial sector investors?" It would be Davis in insurance; they've done insurance for a long time. It would be people who have concentrated in banks if we're doing banks, and that's the way I would do it.

I would not do this at home, kids.

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The article Financial Stocks: Undervalued, or Value Trap? originally appeared on

Matt Koppenheffer and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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