What a fantastic six months it’s been for Merchants Bancorp. Shares of the company have skyrocketed 55.3%, hitting $48.89. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Merchants Bancorp, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why Is Merchants Bancorp Not Exciting?
Despite the momentum, we're sitting this one out for now. Here are three reasons you should be careful with MBIN and a stock we'd rather own.
1. Low Net Interest Margin Reveals Weak Loan Book Profitability
The net interest margin (NIM) is a key profitability indicator that measures the difference between what a bank earns on its loans and what it pays on its deposits. This metric measures how efficiently one can generate income from its core lending activities.
Over the past two years, we can see that Merchants Bancorp’s net interest margin averaged a weak 2.9%, reflecting its high servicing and capital costs.
2. EPS Growth Has Stalled
Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.
Merchants Bancorp’s flat EPS over the last five years was below its 14.1% annualized revenue growth. This tells us the company became less profitable on a per-share basis as it expanded.
Leverage is core to a financial firm’s business model (loans funded by deposits). To ensure economic stability and avoid a repeat of the 2008 GFC, regulators require certain levels of capital and liquidity, focusing on the Tier 1 capital ratio.
Tier 1 capital is the highest-quality capital that a firm holds, consisting primarily of common stock and retained earnings, but also physical gold. It serves as the primary cushion against losses and is the first line of defense in times of financial distress.
This capital is divided by risk-weighted assets to derive the Tier 1 capital ratio. Risk-weighted means that cash and US treasury securities are assigned little risk while unsecured consumer loans and equity investments get much higher risk weights, for example.
New regulation after the 2008 financial crisis requires that all firms must maintain a Tier 1 capital ratio greater than 4.5%. On top of this, there are additional buffers based on scale, risk profile, and other regulatory classifications, so that at the end of the day, firms generally must maintain a 7-10% ratio at minimum.
Over the last two years, Merchants Bancorp has averaged a Tier 1 capital ratio of 9.2%, which is considered unsafe in the event of a black swan or if macro or market conditions suddenly deteriorate. For this reason alone, we will be crossing it off our shopping list.
Final Judgment
Merchants Bancorp isn’t a terrible business, but it doesn’t pass our quality test. Following the recent surge, the stock trades at 1× forward P/B (or $48.89 per share). This valuation multiple is fair, but we don’t have much faith in the company. We're pretty confident there are superior stocks to buy right now. We’d suggest looking at the most dominant software business in the world.
Stocks We Would Buy Instead of Merchants Bancorp
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