Updated on September 25th, 2020 by Aristofanis Papadatos
The Dividend Kings consist of companies that have raised their dividends for at least fifty years in a row. Many of the companies have turned into huge multinational corporations over the decades, but not all of them. You can see the full list of all 30 Dividend Kings here.
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Farmers & Merchants Bancorp (FMCB) has paid uninterrupted dividends for 85 consecutive years and has raised its dividend for 55 consecutive years, has remained a relatively small company, trading at a market capitalization of just $573 million. However, a small market cap is not a negative feature when investing; quite the contrary.
Despite its small size, the company has many things going in its favor, and shareholders are likely to see compelling returns going forward. The dividend yield is higher than the broad market’s yield, and there is a lot of room for more dividend raises down the road.
Business Overview
F&M Bank was founded in 1916. It operates 32 branches across the Central Valley and East Bay areas in California. F&M Bank is a full service community bank and thus offers loans, deposits, equipment leasing and treasury management products to businesses, as well as a full range of consumer banking products.
In spite of operating just 32 branches, F&M Bank has grown its asset base significantly over time. F&M Bank’s $4.3 billion in assets and $404 million of book value mean that each branch has an average of $134 million in assets (and $13 million of book value). Thanks to its expansion in recent years, F&M Bank has become the 13th largest bank lender to agriculture in the U.S. and the largest community bank lender to agriculture west of the Rocky Mountains.
Just like all the other banks, F&M is currently facing a strong headwind due to the coronavirus crisis, which has caused a severe recession and thus it has rendered many individuals and companies unable to service their loans, at least in the short term.
However, thanks to its conservative management, F&M Bank has exhibited remarkable resilience amid the pandemic. While most banks recorded significant loan loss provisions due to the pandemic in the second quarter, F&M Bank booked provisions for loan losses equal to only 1.8% of its portfolio.
In addition, while its net interest margin shrank from 4.5% in the prior year’s quarter to 3.8% due to the aggressive interest rate cuts implemented by the Fed, its net interest income edged up thanks to the strong growth of its interest-earning asset base. Overall, F&M Bank managed to grow its earnings per share by 0.6% in the most adverse quarter it has faced in years. The superior performance of F&M Bank amid the pandemic is the major factor behind its outperformance vs. the financial sector this year.
Growth Prospects
F&M Bank is conservatively managed and it had not made an acquisition since 1985, until four years ago. However, in the last four years, it has pursued a much more aggressive growth strategy. It acquired Delta National Bancorp in 2016 and thus it increased the number of its locations by 4. Moreover, in late 2018, it acquired Bank of Rio Vista and thus expanded in the San Francisco East Bay Area.
F&M Bank has grown its earnings per share at an 11.3% average annual rate over the last decade. However, it has enjoyed some non-recurring tailwinds over this period. In 2018, the bank benefited from a steep reduction in the corporate tax rate and grew its earnings per share by 60%. In addition, in 2019, it greatly benefited from its acquisition of Bank of Rio Vista. As a result, investors should not expect double-digit earnings growth in the upcoming years in order to be on the safe side.
Moreover, just like all the other banks, F&M Bank is currently facing a strong headwind due to the record-low interest rates that have resulted from the response of the Fed to the pandemic. The economy has begun to recover from the pandemic in the third quarter but it will probably take years for the unemployment rate to return to its pre-pandemic level. It is thus prudent to expect suppressed interest rates in the next few years.
Low interest rates constitute a headwind for banks and individuals who have a high amount of assets and thus earn low returns on their assets. Moreover, when interest rates are low, the spread between the lending rate and the borrowing rate of banks shrinks and thus compresses their net interest margin, which is a key component of their earnings. This headwind is likely to weigh on the results of banks for the next few years, though we expect interest rates to rise from their current levels over a 5-year horizon.
Overall, we expect F&M Bank to grow its earnings per share by approximately 5% per year over the next five years thanks to the consistent growth of its asset and loan portfolios, a possible increase in the number of its physical locations and higher interest rates over this time horizon.
Competitive Advantages & Recession Performance
F&M Bank is not a big bank at all — the company’s market cap is just several hundred million dollars. The bank nevertheless has been a solid performer for a very long time, and it remained stable during the last financial crisis
F&M Bank’s net earnings declined minimally during the 2008-2009 recession, with profits dropping by about ten percent. That is a huge contrast to what other banks had to report during that time. Earnings-per-share during the Great Recession are below:
- 2007 earnings-per-share of $28.05
- 2008 earnings-per-share of $28.69 (2.3% increase)
- 2009 earnings-per-share of $25.57 (11% decline)
- 2010 earnings-per-share of $27.05 (5.8% increase)
Major banks suffered earnings declines of 80% or even more during the last financial crisis. F&M Bank, with its focus on community banking and not on more speculative, riskier businesses, has been a much safer investment during those troubled times.
As F&M Bank has not made any changes to its business model since then, it is still exceptionally resilient to recessions, at least relative to most banks. The bank currently has a tier 1 capital ratio of 9.6%, which results in the highest regulatory classification of “well capitalized”, and has extremely few non-performing loans. It is thus one of the most resilient banks in the ongoing downturn, which has been caused by the pandemic.
The conservative management of F&M Bank results in slower growth during periods of economic growth but results in higher long-term returns thanks to the superior returns during rough economic periods, when most banks see their earnings collapse. The prudent management of F&M Bank also helps explain its exceptional dividend growth streak. Most banks operate with high leverage. Consequently, their earnings slump during downturns and thus they cannot sustain multi-year dividend growth streaks.
F&M Bank also has a very low beta of just 0.41. This means that the stock price does not decline much in a market downturn, which makes F&M Bank a relatively stable, non-volatile holding. This feature is paramount during broad market sell-offs, as it makes it easier for investors to avoid panic selling and maintain a long-term investing perspective.
Valuation & Expected Returns
Based on a share price of $718 and expected earnings per share of $73.00 this year, F&M Bank is trading at a price-to-earnings ratio of 9.8.
The stock has traded at an average price-to-earnings ratio of 14.3 over the last decade but we assume a fair earnings multiple of 12.0 due to the small market cap of the stock. If F&M Bank reaches our fair value estimate over the next five years, it will enjoy a 4.1% annualized gain in its returns thanks to the expansion of its valuation level.
Total returns are comprised of share price gains and the dividends a stock pays. F&M Bank currently yields 2.0%, which is higher than the broad market’s dividend yield.
Given 5% expected earnings-per-share growth, the 2.0% dividend and a 4.1% annualized expansion of the price-to-earnings ratio, we expect F&M Bank to offer a 10.9% average annual return over the next five years.
Final Thoughts
Due to its small market cap, F&M Bank passes under the radar of most investors. This is unfortunate, as F&M Bank is an exceptionally well-managed company, which has also begun to pursue growth aggressively in the last few years.
Thanks to its resilience to recessions, F&M Bank offers a compelling risk-adjusted expected return and thus it is an attractive candidate for those who want to gain exposure to the beaten down financial sector. The only caveat is the low liquidity of the stock, which makes it hard to allocate a great amount of capital on the stock.
