Bank shares have had an enviable run over the last two years, with some of them seeing their value nearly triple since the end of 2011. There are a multitude of factors that have been responsible for this, including a steady improvement in economic conditions, focused efforts by the banks to improve their business models and to work through their legal backlogs, and a slew of regulatory changes aimed at strengthening the banking sector. This has significantly helped improve investor sentiment towards the industry, which took a beating during the economic downturn.
How much of this growth can be attributed to tangible improvements in the banks’ balance sheets, and how much is purely due to more favorable investor sentiments? An answer to this question can be obtained by studying the trends in price-to-book (P/B) ratios for these banks over the years, as the metric tempers absolute growth figures in share price with the bank’s underlying financial condition (captured by the book value per share). This is why the P/B ratio is often used by investors to gauge whether the shares are being priced too cautiously or too aggressively.
Interestingly, no other sector captures the wide range of P/B ratios and their meanings so well as the banks do. While Bank of America (NYSE:BAC) and Citigroup (NYSE:C) trade at notable 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 more than double what they are worth on the bank’s books. In this article we provide an overview of the trend displayed by P/B ratios for some of the country’s biggest commercial banks over the last three years, while reflecting on the possible reasons for the disparities.
Marked 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 P/B ratios for the country’s largest banks at the end of each of the last three years. 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.
|Bank of America||27.7%||57.4%||75.2%|
The table highlights the fact 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. The figures were at their lowest values since the global economic downturn of 2008 in Q3 2011 due to Europe’s worsening economic condition, and have steadily recovered to their current highs.
Bank of America’s stock was trading at less than a third of its book value in late 2011 due to rising fears about the quality of the bank’s loan portfolio, as well as a spurt of high-profile lawsuits. And while the bank’s share prices have recovered considerably since then, the fact that its P/B ratio is still just 75% shows that investors are still skeptical about its loan book and remain worried about its legal burden. It is therefore no surprise that every time Bank of America announces the settlement of a lawsuit, investors cheer the decision with a boost in its share price, even though the settlement amounts are often billions of dollars. Citigroup faces a similar fate to Bank of America with its slow-off-the-block performance over recent years, and the billions of non-core assets housed under Citi Holdings reducing its value in investors’ eyes.
The country’s largest banking group, JPMorgan Chase, has historically enjoyed being priced close to its book value. This is because the bank’s business model which was barely affected by the economic downturn is perceived by investors as stable and mature. This is also the reason why JPMorgan is often portrayed as the poster child of the banking industry. On the other hand, despite relying on a much more volatile trading-focused business model, Goldman Sachs also elicits strong confidence from investors due to its strength in the investment banking industry. This would explain the bank’s P/B ratio remaining around 1 historically. In sharp contrast, Morgan Stanley’s P/B ratio suffered considerably in 2010-2011 because of it had the highest exposure to sovereign debt issued by peripheral European nations among all U.S. banks. The investment bank has had to work hard over recent years to make investors see its business model more favorably by revamping its structure to increase its brokerage revenues while reducing focus on trading activities in a bid to reduce its risk profile.
U.S. Bancorp’s P/B ratio figure sends out an interesting signal – investors love its plain vanilla traditional banking business and value the bank at more than twice 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, U.S. Bancorp is very balanced in the banking services it offers – something that acts as an additional hedging policy to an already risk-averse business model.
The graph below summarizes the performance of these banks’ shares over the last 52-week period compared to their book values. Each bar represents the range at which shares of a particular bank have traded over the last 52 weeks (the 52-week high and low values) and the dot shows the book value relative to the market price range. The graph demonstrates the observation we made earlier that shares of U.S. Bancorp and Wells Fargo have consistently traded at a premium to their book value, shares of JPMorgan and Goldman have fluctuated around their book value while shares of Bank of America and Citigroup have yet to reach their book value since the downturn.