A new feature we’re working on is graphing all banks against each other based on valuations or operating metrics. I put together five graphs that I feel depicts where we are in terms of general bank valuations at this point in the market cycle.
The first graph is of all listed banks measured by their P/E and P/B ratio against relevant banking indices. This is a unique graph for two reasons. It clearly shows that the US banking system is filled with a number of small banks and a few larger banks. The second reason this graph is unique is that it highlights that relative banking value lies in two areas, very small banks, and a few larger banks.
The giant red line on the chart is a relative value of 1. If a bank is plotted above this line they are trading for a multiple that’s richer than the bank index multiples. If a bank trades below the red line they are trading for less than index multiples. On the far right side of the graph are three points they are JPMorgan, Bank of America and Citigroup. The three largest banks in the US are slightly undervalued on a relative basis.
Seeing as how the banking industry is comprised of so many small banks I thought it might be helpful to zoom in on banks with less than $1b in assets. Most of the banks with less than $1b in assets are trading for less than their relative value. The problem for investors is that many banks with less than $1b in assets are considered too small to be invested in. This size factor is a likely explanation for the valuation difference.
The next graph shows banks plotted by their market cap and P/E ratio. As in the other graphs there is a large cluster of banks around the bottom left corner representing hundreds of smaller community banks.
Most banks are trading for less than 20x earnings. There are a number of small banks trading with high P/E ratios. When a small stock trades for a high P/E ratio usually it’s because investors expect future growth. For small banks it’s more likely they are barely profitable but investors are valuing them by P/B or pro-forma earning power to an acquirer rather than current earnings.
A misconception I hear often is that a bank earning less than 10% on their equity is ‘worthless’. With low rates and higher required capital ratios fewer banks are earning high returns on equity. In the most recent quarter 2217 banks earned more than 10% on their equity out of 6598 banks, or 33.6%. This is down from the highs of 2005 and 2006 when 50% of banks earned more than 10% on equity.
When looking for an investment the sweet spot on the below graph are banks trading for less than book value but earning more than 10% on equity. There are not many banks like this, but more than enough to dedicate further research time to, and many that are worth investment consideration. As a note, I excluded banks with less than $500m in assets to screen out the majority of the negative outliers. These are banks with considerable losses trading for returns on equity well below 1.
The last graph I have included is return on equity graphed against the P/E ratio for large banks. I’ve included this graph to highlight what I mentioned above that there are a number of very large banks still trading very cheaply. Right on the intersection of a P/E of 10 and ROE of 10% you have Fifth Third Bancorp (FITB). Below a P/E of 15 there are 11 banks trading with ROE’s greater than 10%. The one outlier is Discover Financial with an ROE of 22% and P/E of 12.
As I reviewed these graphs the conclusion I came to was that there are still plenty of banks trading at favorable valuations. Many investors feel like they missed the boat for not investing in financials in 2009/2010/2011/2012, but I’m not sure they missed anything. In 2009 and 2010 if an investor purchased any bank and the bank survived they earned multiples on their money. So yes, those opportunities are gone, but the chance to own an undervalued bank in an environment with increased M&A and rising multiples hasn’t disappeared.