The price-to-book (P/B) ratio of a company’s share is often used by investors as a quick tool to gauge whether the shares are being priced too cautiously or too aggressively, as 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.
And as it turns out, no other sector captures the wide range of P/B ratios and their meanings so well as the banks do. While banking giants Bank of America (NYSE:BAC) and Citigroup (NYSE:C) 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. 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 two years, while reflecting on the possible reasons for the disparities.
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The table below shows the price-to-book ratios for the banks at the end of each of the last nine 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|
|Bank of America||63.0%||54.0%||29.4%||27.7%||48.3%||40.6%||43.3%||57.4%||60.0%|
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 slowly recover completely by the end of Q1 2013.
Bank of America stand out as being the bank which was trading at less than a third of its book value for nearly half a year due to rising fears about the quality of the bank’s loan portfolio, as well as due to a spurt of high-profile lawsuits against the bank in late 2011. And while the bank’s share prices have recovered considerably since then, the fact that its P/B ratio is still 60%, shows that investors are still skeptical about its loan book and remain worried about its legal burden. It is hence, no surprise that every time Bank of America announces the settlement of a lawsuit, investors cheer the decision with a boost in share prices, even though settlement amounts are often billions of dollars.
Citigroup faces a similar fate as Bank of America with its slow-off-the-block performance over the recent years, and the billion of non-core assets housed under Citi Holdings reducing its value in investors’ eyes. As for JPMorgan, investors have historically priced the banking group’s share close to its book value – representing a stable and mature business model. The bank’s image, however, took a beating in early 2012, when reports of a $6 billion trading loss raised concerns about its risk management policies. Although share prices have improved since the debacle, the P/B ratio of less than 1 is most likely due to remaining (albeit lower) concerns 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 high P/B ratios.
U.S. Bancorp’s P/B ratio figures sends out a rather unique signal – 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.