As long term investors, how should we think about the long term returns we can expect from a company? Let's examine this for Bank OZK in this article!
In late July 2022, Bank OZK released its earnings for 2022 Q2. Overall, the results were good, with its pre-tax pre-provision net revenue (PPNR) growing by 11% y/y (to $183 million), and there was not any material unexpected development.
That’s the short term quarterly performance. What about the long term returns that an investor can broadly expect from an investment in Bank OZK?
As Marathon Asset Management puts it well, “Over the long run, it is a company’s return on capital, not changes in quarterly earnings, which primarily determines the direction of its share price. The return on capital of any company is largely subject to the state of competition within its industry.”
Let’s look back at Bank OZK’s past long term performance first. Earlier in the month of July, Bank OZK celebrated its 25th anniversary of its initial public offering (IPO). Investors who had purchased Bank OZK’s stocks during its IPO and reinvested the dividends in the company’s shares would have realised a 17.8% compounded annual return over that 25-year period, more than double that of the 7.8% for S&P 500 Index, or almost triple that of the 6.0% for the Nasdaq Bank Index.
That’s an impressive investor return for such a long period. But that’s historical returns, in hindsight. How about the potential future returns for investing in Bank OZK? Can Bank OZK continue to generate high returns for shareholders in the future?
Today, let’s examine this, and think about the rough future long term returns from investing in Bank OZK.
As we have previously discussed in MoneyWiseSmart’s courses, the long term return from investing in a company can be broadly estimated from considering the below:
% change in intrinsic value of the company over time, which could come from organic growth or merger & acquisitions
Dividend yield %
Buyback yield %
Dividend yield
Let’s take a look at these 3 factors for Bank OZK, starting with the easiest one – the dividend yield %. Since going public in 1997, Bank OZK has consistently increased its cash dividend in every quarter (and year). In July 2022, it declared a quarterly dividend of $0.32. Assuming it would distribute at least the same amount in the next quarter, the dividend for 2022 would total up to at least $1.25 per share. Based on Bank OZK’s share price of ~$40 (as at late July 2022), that’s a dividend yield of ~3% (pre-tax).
Capital allocation
Next, let’s look at the other two components – buyback yield and growth in intrinsic value of the business.
We will start with looking at how Bank OZK has been allocating its capital first. For simplicity, we will look at how it has been deploying its net income earned.
In the past 8 years (from 2014 to 2021), Bank OZK had earned in total $2.7 billion of net income, and it:
Distributed 27% (or $0.7 billion) of it for dividends (with the % spent pretty consistent at 20%-30% in each year);
Deployed 8% (or $0.2 billion) of it for share buybacks, with it only really started being more open to and actually doing major buybacks in 2021; and
Retained the remaining ~65% (or $1.7 billion).
Buyback yield
On buybacks, in 2021, Bank OZK spent ~$0.2 billion, or 34% of its net income for that year, to repurchase ~4 million shares, which was ~3.3% of total shares (in 2020). This implies a ~3.5% buyback yield, which is calculated as: [ 1 / ( 1 – 3.3% ) ] – 1.
In the first half of 2022, Bank OZK became increasingly more open to buybacks and had sped up the buybacks. It spent ~$280 million (or ~105% of its net income) to repurchase ~6.6 million shares (i.e. ~5% of total shares). After these repurchases, it still had ~$180 million repurchase authorisation based on the current buyback program (authorised in July 2021, and increased in October 2021). In the first 20 days of July, it had already spent $20 million on buybacks, and expected to use up all the authorisation by the end of the year.
This level of buyback activity is not sustainable in the long term (without raising new capital), as the amount spent on buyback is more than its net income. Let’s assume that, on average, in the long run, Bank OZK spends:
~30% of net income on dividends, generating a dividend yield of 3% (which implies a P/E of 10x, calculated as 30% allocation divided by 3% yield);
~10%-30% of net income on buybacks; and
the remaining ~40%-60% on reinvestments into the business, noting that the management said that they would always prioritise organic growth if they can find good opportunities.
The buyback yield would depend on various factors, including market conditions (like Bank OZK’s share price), excess cash and other opportunities faced by Bank OZK, etc.
To get a rough sense of the numbers, if we assume that Bank OZK spends 10% of net income on buybacks, and if it manages to buy back its shares when the shares are trading at a P/E of ~10x, then it could buy back 1.0% of shares (= 10% / 10). This translates to a slightly higher buyback yield of 1.01%
If we assume that Bank OZK spends a higher 30% of net income on buybacks instead, then the buyback yield is 3.09%.
Increase in intrinsic value
For simplicity, let’s assume that Bank OZK would mainly grow its business organically and not make many major acquisitions (or if it does, the returns on capital deployed achieved are similar as the organic reinvestments).
To grow its organic business well, Bank OZK would have to:
Deploy its capital (retained) into income-generating assets, which are mainly loans, so we have to monitor its loan book growth. On this front, in the latest quarter, Bank OZK had a record RESG loan origination, but also record RESG loan repayments. Overall, the management is optimistic about the loan growth prospects in 2022 to 2024 (under a wide range of macroeconomic scenarios), given the high amount ($17 billion) of unfunded loans that the company had secured (versus $14 billion a year ago, or $15 billion a quarter ago);
Achieve a good net interest margin (NIM) on those loans, which means:
a high loan yield with low write-offs (so asset quality matters, which Bank OZK is focused on and has good records on for a few decades); and
a good deposit base, so ideally a higher proportion of deposits from non- or low- interesting incurring deposits, and/ or a lower cost of interest bearing deposit (COIBD). On the NIM front, in the latest quarter, Bank OZK’s NIM has improved to a high 4.52% (i.e. +0.28% point q/q, or +0.57% point y/y), as its loan yield increased faster than its COIBD, so that’s good;
Maintain cost discipline to achieve low operating costs, which translates to a low efficiency ratio. On this front, Bank OZK has been performing well above industry average over the past two decades, and has maintained a low 37.3% ratio in the latest quarter (compared to 60+% for the industry in the past few quarters).
In the past 8 years (from 2014 to 2021), Bank OZK had, broadly speaking, retained or reinvested ~65% of its net income in its business. On the equity retained in the business, except for 2020, it had mainly achieved a return on equity (ROE) of ~10%-15%, and a return on tangible equity (ROTE) of ~13%-17%.
Thinking about the growth in intrinsic value of the business, if we assume that its trading multiple, like P/E, remains the same, then the growth would come from its earnings growth.
If we assume that Bank OZK would reinvest 60% of its earnings into the business, and if it achieves a return on capital of ~12%-17%, then the earnings growth would be ~7%-10%.
If it reinvests a lower 40% of its earnings into the business, and if it achieves the same return on capital (of ~12%-17%), then the earnings growth would be ~5%-7%.
Overall long term returns
Considering the 3 factors above, per the table below (the 1st scenario), if Bank OZK spends 30%, 10% and 60% of its net income on dividends, buybacks and reinvestments respectively, then the total investor return from investing in Bank OZK would be ~11%-14% a year.
On the calculations, the higher end of 14% is calculated as the summation of:
3.0% dividend yield; and
11.3% growth in intrinsic value of company per share, which is calculated as: [ (1 + 10.2% earnings growth) * (1 + 1.01% buyback yield) ] – 1
If Bank OZK spends a higher % (30%) on buybacks and a lower % (40%) on reinvestment instead, i.e. the 2nd scenario in the table above, the overall return would be slightly lower, at ~11%-13%.
Do note that the above calculations assume that Bank OZK would:
trade at the same multiple (P/E multiple in this case) over time, so that its intrinsic value growth over time is equal to its earnings growth; and
buy back its shares at an average P/E level of 10 times. In reality, if the management are good capital allocators, then they would likely be buying more when the price is lower, and less when the price is higher, assuming all else equals.
In short, based on the assumptions and calculations above, if an investor aims to achieve an annual return of 15% or more, the investor would have to also benefit from a multiple expansion to hit that return (unless some of the assumptions change, e.g. if its return on capital in the future increases to a higher level like in the past).
For our free analysis of Bank OZK and other high quality companies, check them out at our free Research Series (linked below).
For our summary analysis of the company, check out the video below.
Subscribe here if you want to be notified of future posts!
P.S. Do join our investment forum on Facebook too where we discuss interesting investment concepts and ideas. If you have enjoyed this article, you will enjoy our other articles here.
Comentarios