by GEOFF GANNON
Truxton (TRUX) is an illiquid, micro-cap bank stock. TRUX is not listed on any stock exchange. It trades “over-the-counter”. And it does not file with the SEC.
The stock has been a fast grower over the last decade. Here are the compound annual growth rates at the company over the last 1 through 9 years.
The bank has two locations (one in Nashville, Tennessee and one in Athens, Georgia). However, only one location (the Nashville HQ) is actually a bank branch. So, I’m going to be calling Truxton a “one branch” bank despite it having two wealth management locations.
The company doesn’t file with the SEC. But, it is not a true “dark” stock. It has a perfectly nice website with an “investor information” section that includes quarterly earnings releases.
Still, if Truxton doesn’t file with the SEC – how can I find enough information to write an article about it?
Truxton – as a U.S. bank – does file reports with the FDIC even though it doesn’t file with the SEC. So, some of the information in this article will be taken from the company’s own – very brief – releases to shareholders (which are not filed with the SEC) while other information is taken from the company’s reports to the FDIC. Truxton also puts out a quarterly newsletter that sometimes provides information I might talk about here. Those 3 sources taken together add up to the portrait of the company I’ll be painting here. Some other info is taken from Glassdoor, local press reports, etc. But, that’s mostly just color.
So, it is possible to research Truxton despite it being a stock that doesn’t file with the SEC.
But, is it possible to actually buy enough Truxton shares to make a difference to your portfolio?
It depends. Are you an individual investor or a fund manager? Do you have a big portfolio or a small portfolio? And – most importantly – are you willing to take a long time to build up a position in a stock and then hold that stock pretty much forever?
No shareholder of any size would have an easy time getting out of Truxton stock quickly. But, if you intended to stick with the company for the long haul – it is possible, if you take your time buying up the position, for individual investors to get enough TRUX shares.
The math works like this…
Truxton shares are illiquid but not un-investable. In an average month, there might be around $300,000 worth of shares trading hands. Let’s round that down to $250,000 to be conservative. Let’s say you can buy 20% of the total volume of shares traded in a stock without much disturbing the price. That’s one-fifth of $250,000 equals $50,000. So, let’s say you can put $50,000 a month into Truxton stock without anyone noticing. That’s $150,000 per quarter, $300,000 every six months, and $600,000 over a year. Most investors don’t put much more than 10% of their portfolio in a single stock. So, if you’re willing to take up to a year to buy it – Truxton is investable for anyone with an account of $6 million or less ($600,000/10% = $6 million).
Now that we know it’s possible for an individual investor to buy enough shares of this bank – if he intends to hold the stock for the long-term – the obvious question is whether this is a good stock to hold for the long-term?
Truxton is an exceptionally small and fast growing bank with very high returns on assets and equity. These things often go hand-in-hand in banking. The very smallest banks enjoy the fastest improving economies of scale as they get bigger. This means that a dollar of extra deposits taken in at a one branch bank will tend to increase EPS faster in percentage terms than it increases deposits in a way that is much less likely to be true at a bank with a thousand branches. We can see this clearly at Truxton. The bank’s return on equity has more than tripled in the last decade. It won’t triple again in the next decade – or likely ever. The reason ROE could grow so quickly in the last 10 years is because it started from such a low level. A new one branch bank is very inefficient compared to an older, multi-branch bank. And then we have the relationship between quick growth in loans, assets under management, book value, etc. and high returns on assets and equity.
A bank’s return on assets drives its return on equity with the only other factor being leverage. If two banks use the same amount of leverage, the bank with the higher ROA will have the higher ROE. And then a bank’s ROE is a necessary – though not sufficient – driver of that bank’s growth in deposits, earning assets (like loans and bonds), etc. A bank’s growth is limited by its return on equity and the demand for deposits and loans. For a bank to make a loan, it generally needs to have deposits to lend (though some banks may borrow to make loans – this is only a temporary solution). How quickly can a bank grow its deposits? That depends on two things. One, how many new clients it can bring in to deposit money with the bank. That’s demand for deposits. But, then there’s also the bank’s ability to take the extra deposits. A bank can’t – for example – double its deposits if it has an ROE of 1%. Deposits – while an economic asset if they are low cost enough – are an accounting liability. So, if a bank increases deposits any faster than it increases equity – the bank will have increased its leverage ratio. Assuming a bank wants to keep its leverage ratio stable – and in the very long-run this is always a safe assumption – the bank shouldn’t increase its deposits faster than it increases its equity. Bank’s can increase equity by issuing preferred stock, issuing common stock, or retaining earnings. There can be some benefit to common shareholders from a bank issuing preferred stock. But, it’s similar to the benefit common shareholders get from any company issuing debt. If the debt is low cost – it can benefit shareholders. But, there’s a limit to how much leverage you can take on. So, it’s always best to assume that any company you are investing in will attempt to keep its leverage stable while you own it. In other words, don’t assume a bank you invest in well fund future deposit growth through preferred stock issuance. That would be like assuming that the supermarket chain you are investing in will fund all future store sites by issuing bonds. It might do that. But, it’s not good for a long-term investor seeking a safe investment to assume that’s where the company will get its funds from. Issuing new common stock hurts existing common stockholders. It dilutes your ownership of the company. There are cases where a stock can be so overpriced that issuing more shares benefits the existing shareholders because the price at which the new shares are sold is so high. However, the only shareholders who really benefit from this are “stuck” shareholders – usually insiders and major holders – who can’t easily sell most their shares in the open market. The truth is that for you – an outside, passive minority shareholder – if it ever makes sense for a company you own stock in to issue more common stock, it makes even more sense for you to just sell your own stock in the company yourself. So, it’s not a good idea to count on either preferred stock issuance or common stock issuance as the source of funding deposit growth. That leaves only one source of funding: retained earnings. A bank’s retained earnings will grow in relation to its equity through the return on equity ratio. If a bank has $40 of book value and earns a 10% return on equity it has $4 of earnings available to retain. Almost all banks will choose to pay some of these earnings out in dividends. Some banks may also choose to use some of these earnings to buy back stock. Whatever is left after the company pays dividends and buys back stock is added to equity. This is the company’s addition to both retained earnings and book value.
Over time, a bank can sustainably grow its deposits (and thus loans and bonds) at the same rate it grows its tangible book value. Basically, the company’s earning power (which comes from the interest received on loans and bonds) can grow as fast the company’s retained earnings. This is how the return on equity at a bank drives growth at that bank. Return on equity is the maximum sustainable growth rate at the bank. Most banks – in fact, almost all U.S. banks – will grow quite a bit slower than their ROE, because they will pay dividends or buy back stock. You can find examples of banks with a 20% ROE and only a 3% growth rate in deposits, loans, etc. This means the bank is using almost every penny it earns to pay dividends and buy back stock. For an example of such a bank see Bank of Hawaii (BOH). For a long time, that bank has earned far more on its equity than there is enough demand in the Hawaiian economy to soak up. The bank has enough fuel to grow 10% or 20% a year. But, the Hawaiian economy is growing only about a tenth as fast as that. And a bank that already has a big market share in Hawaii can’t really grow much faster than the Hawaiian economy as a whole. So, BOH has the fuel. But, it doesn’t have enough demand for growth to use up that fuel. So, it must pay that fuel out to shareholders. If BOH didn’t do this, it’d become less and less leveraged every year.
Truxton has both a lot of fuel (a high ROE caused by a very high ROA) and a lot of demand in its local Nashville market. Nashville is a fast growing city. And the richer population in Nashville – which is what Truxton, as a private bank and wealth management company is focused on – is an even faster growing part of that city.
So, we know how Truxton has been growing. It started with a low ROE. But, as the economies of scale of a one branch bank with a rapidly growing client base kicked in, that ROE rose and rose and rose. This high ROE translated into a lot of fuel – a lot of retained earnings growth – that allowed the bank to maintain the same leverage ratio each year even while taking in a lot more deposits and making a lot more loans. And then the local high-end Nashville market provided a lot of demand – unlike the Hawaiian market for BOH – where TRUX could burn its retained earnings fuel. In other words, Truxton is a growth story. Or, at least, it had been a growth story over the last 10 years.
Let’s put some exact figures on this growth. Just how fast did Truxton grow in its early years?
Truxton was founded in the early 2000s. But, it has only been public for a little over 9 years. During those 9 years, the company compounded its earnings per share at 29% a year. While EPS would seem to be the best kind of growth for shareholders to worry about – there’s an issue here. Ten years ago, companies paid higher taxes than they do today. So, the one-time federal corporate tax rate cut from 35% to 21% would skew compound growth figures higher. Even over as long as a 9 year period, that one-time tax cut could add between 2% and 3% a year to your EPS growth calculation. What I mean here is that if you take the period from 2009-2018 using 2009 EPS as your start point and 2018 as your end point and do a CAGR calculation, your annual compound growth rate will be higher by over 2% a year over those 9 years simply because your end point (2018) has a lower corporate tax rate (21%) than your 2009 start point (35%). These growth figures would be distorted even higher on an annual basis if we were to use short-term – that is, more recent – EPS growth numbers like asking how quickly did Truxton compound EPS over the last 5 years.
In other words: all of Truxton’s EPS growth rates – whether we are talking 15 years, 10 years, 5 years, or 3 years – are exaggerated higher by the tax cut. The exaggeration is quite small over say a 15-year period, quite huge over a 3-year period, but present in all periods.
To avoid this problem, we can simply calculate the growth in Truxton’s earnings power using pre-tax numbers.
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