A High-Quality Investment Bank
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Investment banks are not for the faint of heart -- their operations are complex and accounting rules are quite soft on disclosure requirements, so it’s hard for investors to get a good understanding of a company's risk exposure in the sector. Besides, government regulation is a permanent source of uncertainty for these companies all over the world.
The collapse of many big players in the industry during 2008/2009 and the recent troubles at Morgan Stanley (NYSE: MS) can serve as a harsh reminder about how uncertain investment banks can be. An investment in one of these companies is necessarily a vote of trust on the company's management team and their risk management skills, since there is no easy way to know what kinds of risks are faced by these institutions.
On the other hand, many investment banks are trading at a steep discount to their book value, meaning they have a considerable upside potential. Big global institutions like Goldman Sachs (NYSE: GS), Morgan Stanley and Nomura Holdings (NYSE: NMR) are trading at valuation ratios in the zone of 50% of their book value, which provides ample room for gains if things turn for the better and investors get more optimistic about the sector in general.
Price to Book Value (P/B) used to be a very popular valuation benchmark for financial institutions some years ago. A bank's book value was supposed to be a fair reflection of the company's equity; since both assets and liabilities are mostly financial, they were believed to be liquid and easy to value. The financial crisis, however, taught a hard lesson to many investors when they realized that assets and liabilities are not easy to asses for financial firms.
That's probably the main reason most investments banks are trading at big discounts to their book value nowadays -- investors have good reasons to doubt about the true value of their assets and liabilities as stated in the balance sheet. If these banks put their houses in order in the coming years, or if the economic climate gets steadily better, increasing earnings for these banks and investors' appetite for risk at the same tome, there is plenty of upside room due to currently depressed valuations in the sector.
One company that stands out is Raymond James (NYSE: RJF). With a PB ratio near 1.5 Raymond James is quite more expensive than its competitors, but it is also much smaller in terms of market cap and also has clearly better fundamentals. Raymond James has Return on Assets (ROA) and Return on Equity (ROE) ratios that are the highest in the group, and it’s also the only investment bank in the table that has a positive track record in earnings per share for the last five years.
Investors need to pay almost triple for a dollar of book value at Raymond James than for other companies in the sector, but there are valid reasons for that. Raymond James has avoided many of the complex and risky investments that competitors undertook during the credit bubble, which has made this investment bank one of the top performers in terms of financial results during the last years.
Being less leveraged than its competitors, Raymond James has the possibility to buy selected loans and other assets from competing banks at attractive prices. Downsizing in the industry also means that Raymond James has easy access to top industry people, brokers and bankers, which the company has been bringing on board to increase profitability and assets under management.
Raymond James has more predictable revenues than most competitors; the company has focused its energies in the wealth management business, which has provided high profitability and more stability than other activities like investment banking. The company has recently acquired Morgan Keegan wealth management in an effort to increase its presence in that lucrative business.
Emerging better than its competitors from the collapse of the credit bubble gave Raymond James the possibility to pursue growth opportunities in a more aggressive fashion, and management seems decided to intelligently capitalize this possibilities. Looking at the evolution of book value per share since the second quarter of 2009 for different companies in the industry shows that Raymond James not only did much better than the other investment banks during the crisis, it has also been able to grow much faster during the recovery due to its financial soundness.
Valuations seem to reflect that Raymond James is the high-quality alternative in the investment banking industry, an idea that can be confirmed by an analysis of financial figures from different companies in the sector. Raymond James is not necessarily the company with the biggest upside potential; other competitors are much cheaper from a valuation pint of view. But long-term investors looking for a solid company with a proven track record at containing risks and growing the business may want to take a look at this high-quality investment bank.
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