Determining the Best Values in Banking
Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
For the first time since the great housing recession the housing market is finally starting to show signs of recovery in both demand and pricing. As a result, banking stocks have been on the rise and many believe these stocks could rally significantly higher. Therefore, I am looking at the top banking stocks and providing one tool to track to help in determining the value of these companies.
The recession destroyed the valuation of most large cap banks, and to this day many are yet to recover. However, in the last six months we have seen a decline in lawsuits (which is good), a housing recovery, a strategic shift among banks, and therefore a rise in valuation.
So the big question moving forward is how to play or invest in large money center banks? If you look at the fundamentals alone it does appear that this class of stocks is undervalued. However, investors need a metric to determine which might be the best value; seeing as how the operations of a bank can become complex. Therefore, one of the best metrics to use might be book-value-per-share.
The book value per share of a company is the value of a company’s stock if all assets were liquidated and all debts were paid. This can be especially valuable with large banks because their debts and assets are so large and complex. In some ways it gives you a price of what the company is actually worth, while also indicating a level of safety. Some might even suggest that a stock trading below its book value is undervalued, has the greatest operational upside, and is also a safe investment. Therefore, let’s look at how the largest banks measure up after posting such large gains in 2012.
- Wells Fargo trades with the largest market cap of the large banks listed above. It has long since been considered one of the top financial institutions in America, and is one of the only banks to be trading with a five year gain. The company does pay a good yield, has industry leading margins, and is highly profitable. Therefore, the fact that it trades above its book value per share should not determine an investor’s opinion, but should indicate that better values exist.
- Much like Wells Fargo, JPMorgan is known for its consistency and its efficiency in an unstable market. The facts that make Wells Fargo attractive are the same ones that can be found in shares of JPMorgan. The only difference is that the company is more attractive from a valuation stand point, which can most likely be attributed to its large investment loss earlier this year.
- Bank of America continues the trend of trading at the deepest discount compared to its book value. The main reason is that investors simply don’t trust the company, due to its performance and the lagging effects of the recession. The stock is now trading at 52-week highs yet remains nearly 50% off its book value. This is a clear indication of value.
- Citigroup is a near mirror of Bank of America. It is not trading at 52-week highs but is close. Yet despite these gains the company remains significantly undervalued compared to its actual worth.
- U.S. Bancorp is the most expensive on this list, presenting the greatest risk based on book value/share price. However, the company has performed exceptionally in terms of fundamentals and is not exposed to the same risks as a larger global bank. This progress and the strength of the company most likely contributes to its valuation. However, in a healthy and growing economy this is a stock that will not see the same level of upside as a Bank of America or Citigroup.
Last year during the massive sell-off within the market, the financial sector was hit hardest. At the time several of these stocks were trading at just 50% and some as low as 30% of their book value per share. Now, in 2012 these stocks have all recovered some of the losses and have added great levels of value to their price. But even still, some continue to trade at deep discounts compared to their stated worth.
The process of determining value based on book value per share is not an exact science, but it does give you a good start in your investment research. You have to remember that certain banks, in particular Bank of America and Citigroup, do have overstated book values due to bad loans that still infect their balance sheets. Therefore, it is very difficult to know with absolute certainty the true value of these assets.
Over the last couple years there has been many write-downs and write-offs for large banks; which does have some measurable impact on the book value of these companies. However, with that being said, I don't believe these instances are significant enough to where it would greatly change the ratio of book value to market capitalization that is being presented above. And the reason is due to the size of these companies and the amount of research and time that goes into valuing their worth.
The bottom line is that these are all very complex businesses, where there’s more than just a top and bottom line number. An investor must be precise in their research, and although a book value per share compared to stock price doesn't tell you everything, it will give you a starting point in researching these very large and complicated businesses.
BrianNichols owns BAC. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!