There is no denying that overall market sentiment towards the banking sector have seen a marked improvement since early 2012. The growth in share prices for the country’s biggest banks over the period are testimony to this fact. But we believe that the price-to-book (P/B) ratio is a far better tool to gauge investor sentiments in an industry as compared to the absolute growth in share price – simply because the former also factors in a company’s underlying financial condition.
Now even a quick glance at the P/B ratios of the largest U.S. banks shows that there is a lot of disparity among them as far as this metric is concerned. While banking giants such as Bank of America (NYSE:BAC) and Citigroup (NYSE:C) continue to trade at considerable discounts to their book value, JPMorgan’s (NYSE: JPM) share price hovers around its book value, whereas U.S. Bancorp (NYSE:USB) finds itself at the far end of the spectrum with its shares demanding close to double than what they are worth on the bank’s books.
But taken together, the trend is unmistakable – the P/B ratio has steadily improved over the quarters. So what exactly does this mean for each of these banks? In this article we try to answer this question while reflecting on the possible reasons for the marked disparity in P/B ratio for the banks.
The P/B ratio serves as a quick tool to gauge whether a company’s shares are being priced too cautiously or too aggressively, as significant differences between the price of a company’s share in the equity market compared to its book of accounts are often a sign of under- or over-valuation. But sometimes skewed P/B ratios have a different story to tell. Very low P/B ratios may actually be because of serious problems with the company’s business model, whereas high P/B ratios could very well be because of strong optimism about the future potential of a company’s business model.
The table below shows the price-to-book ratios for the banks at the end of each of the last ten quarters. The figures are obtained by dividing each bank’s closing share price on the last trading day for the period with the book value per share figure at period end reported by the banks in their respective quarterly SEC filings.
|Q1 2011||Q2 2011||Q3 2011||Q4 2011||Q1 2012||Q2 2012||Q3 2012||Q4 2012||Q1 2013||Q2 2013|
|Bank of America||63.0%||54.0%||29.4%||27.7%||48.3%||40.6%||43.3%||57.4%||60.3%||63.7%|
The table highlights the fact we mentioned earlier – that there is a considerable difference in the way investors value the country’s biggest banks, as is evident from the wide range of P/B ratios shown above. Quite notably, it can be seen that the banks’ P/B ratios have gone through a complete cycle over the two-year period. The figures fell from highs in early 2011, to their lowest values since the global economic downturn of 2008, in Q3 2011, due to Europe’s worsening economic condition to recover completely by early 2013.
Bank of America stands out as the bank with the lowest P/B ratio here. Things were particularly bad in the latter half of 2011 when rising fears about the quality of the bank’s loan portfolio and the spurt in high-profile lawsuits against the bank triggered a massive sell-off of its shares. And while the bank’s share prices have recovered considerably since then, the fact that its P/B ratio is still below 65% shows that investors are still skeptical about its loan book and remain worried about its legal burden. This is also why Bank of America’s share price jumps every time it announces the settlement of a lawsuit – even when settlement amounts are often billions of dollars – as it helps reduce the legal uncertainty that clouds the bank’s value.
With billions of non-core assets still waiting to be disposed of, Citigroup is also subject to similar scrutiny by investors – something that shows through in its P/B ratio figure of around 75%.
As the poster child for the banking industry, JPMorgan’s shares have largely been priced around its book value – representing a stable and mature business model. That is, of course, excluding early 2012 when the bank’s image took a beating in the wake of its $6 billion trading. The fact that JPMorgan’s P/B ratio returned to 1 by the end of Q2 2013 can be taken as a good signal of the fact that investors no longer have much to worry about the bank’s business model.
Wells Fargo and Capital One both share one thing in common – their business model emphasize on one aspect of banking more than the others. While Wells Fargo has concentrated its efforts more on mortgage banking over the recent years, Capital One still draws a bulk of its value from its credit card business. Their strengths in their respective areas of expertise coupled with their images unencumbered by legal battles, are most likely the reason for their pretty high P/B ratios.
U.S. Bancorp’s P/B ratio figures stand out from that for its peers – investors genuinely love its plain vanilla traditional banking business and value the bank at almost twice of what it is worth on paper. The biggest reason for this is the bank’s aggressive acquisition policy, which has helped it grow its business considerably since the economic downturn. Also, as can be seen from the chart below, U.S. Bancorp is quite balanced in the banking services it offers – something that acts as an additional hedging policy to an already risk-averse business model. So much so that the bank which has grown considerably over recent years thanks to the refinancing boom in the mortgage industry continues to remain an investor favorite despite reporting a sequential decline in mortgage origination for the first two quarters of the year.