|Shares Out. (in M):||486||P/E||10||0|
|Market Cap (in $M):||46,219||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
The relationship between interest rates and market valuations has been a widely discussed topic over the past year. As the Fed has cut interest rates, capital has flowed into higher yielding equities, so that equity risk premiums would correspondingly adjust.
However, valuations have not evenly increased across all sectors. Banks, in particular, have seen their multiples trade below historical averages, implying that the equity risk premium for banks has meaningfully widened.
This is in spite of the fact that banks are less risky than they have been in decades. Basel capital requirements and routine stress tests administered by the Federal Reserve have added a new margin of safety which did not exist prior to the Great Recession. We believe that in this circumstance, there is a large market dislocation causing bank stocks to trade substantially below intrinsic value.
In addition to this dislocation, today’s backdrop makes investing in bank stocks particularly attractive. A strong macro environment evidenced by solid GDP growth, tax cuts, a Trump Administration that is focused on deregulating financial services, and rising interest rates (and net interest margins).
In the short-term, investors are concerned about rising charge-offs and movements in the yield curve that might impact net interest margins, but we believe there is a large margin of safety given the historically wide equity risk premium and the fundamentals described above.
Capital One’s business is relatively simple. It makes loans in three main segments: credit cards, auto loans and commercial lending (composed of commercial real estate and C&I loans).
The company’s goal has been to make loans in sectors where it has the ability to gain scale quickly and become one of the top lenders in those areas. Hence, on the consumer side, Capital One has focused on credit cards and auto loans and on the commercial side in real estate and healthcare, for example.
Unlike some of the other banks, Capital One does not earn trading fees or investment banking revenue. The primary sources of revenue come from interest income on loans, interchange fees, and service charges.
Capital One is also different from the other lenders because the bank has exposure to subprime credit card and auto customers.
These loans are very profitable for the company and earn the company very high returns on capital. Capital One is often perceived as a lower quality bank because of its exposure to subprime credit, but data indicates that these asset classes on a macro level held up during the financial crisis (particularly auto loans).