From USD 2.84 (1985) to USD 159.36 before the sharp fall due to subprime crisis, with the offer from JP Morgan of USD 2 per share about a week ago to revised USD 10 yesterday. If you the one of the shareholder, how you feel? Bear in mind that Bear Stearns Book Value (BV) is about USD 84 per share.
"You also have to consider the massive writeoffs that the Street has taken. Thus far, Citigroup has taken $32 billion in writedowns related to the subprime crisis. Merrill Lynch's writedowns have totaled $22 billion. So were Citi's 2006 profits really the reported $21.2 billion, and were Merrill's the reported $7.5 billion? Or was some percentage of that an illusion? If Bear can be sold for $2 or $10 a share, then how solid was Bear Stearns' $84 per share in reported book value?
Thought about more broadly, if commentators are right that mortgage losses alone will total $300 billion to $500 billion, then, as Inker writes, "profits that look like they have been 2.25% of GDP in the past several years have actually been more like 1.75%, if we smooth the losses over the last 3 years and into next year as rough justice." And of course, mortgage losses are only a subset of the total losses.
Think back to what Ken Lewis, the CEO of Bank of America (BAC, Fortune 500), said last fall when his company announced its first round of writedowns: "Making money for several years, only to give most of it back in one year, is not a brilliant business model."
Inker says that the data doesn't point to any firm conclusions about what the level of financial profits should be. His best guess, though, is that a "normal" level of profits would be about half the amount that the financial sector reported in 2006.
Then, you also have to think about the multiple of those earnings that investors should be willing to pay. In a paper published in the fall of 2005, risk management gurus Leslie Rahl and Barbara Lucas of Capital Markets Risk Advisors, noted that in the past decade, a lot of things have happened that aren't supposed to happen, from the interest rate hikes of 1994 to the 1998 collapse of LTCM to the 2001 terrorist attacks. Or as the authors put it, "once-in-a-lifetime events seem to occur every few years."
If that's the case and if such events now mean that Bear Stearns (BSC, Fortune 500) can go from seemingly viable to threatening to bring down the entire financial system in the space of a week - then what sort of multiple should investors pay for Bear, or for any financial firm? Maybe investors shouldn't pay 12 times earnings, and maybe they should pay a discount to, rather than a multiple of, reported book value.
Of course, trying to guess how this will play out is just that - guessing. But if you say, for instance, that Merrill's normalized profits would be half the 2006 level, you get to about $4 billion. If you think that we should be willing to pay a smaller multiple for those earnings than we did in the past - let's be generous and say 10 times - then you get to a total market value for Merrill Lynch of $40 billion. That's still a 10% discount from today's valuation."
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What about if you bought the shares based on rumour that Warren Buffett might take minority stake of Bear Stearns in September 2007 when the price is about USD 123 per share?
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