Bank stocks are difficult to value but the P/B ratio is often a good indicator
Banks are vital to the good functioning of the economy. However, since the 2007-08 financial crisis, they have suffered from negative press as they are seen as the epicenter of greed and crony capitalism.
Investors don’t seem to care: Warren Buffet recently declared that “bank stocks are great” because they “earn between 12% and 16% or so on net tangible assets. That’s a good business, that’s a fantastic business against the long-term bond at 2%“.
Further, he also likes the fact that Bank of America is “buying in a lot of stock every year so your ownership of BAC this year will probably go up 7 or 8% without us spending a dime. I’d like to own any business, any good business, where my ownership just goes up 7 or 8% every year without me spending any money and, on top of it, I get a dividend“.
Should the average retail investor be as excited as Buffet is when it comes to bank stocks? I believe they could be.
With stocks reaching new lows as a result of the coronavirus crisis, some major banks are looking incredibly cheap.
When it comes to valuing bank stocks, investors like to look at the Price/Book Ratio (P/B) because it offers a very good reflection of the bank’s assets.
Let’s take a look at three banks with Price/Book ratios inferior to 1 and determine if they represent good investment opportunities.
The 2007-08 crisis almost saw the end of Bank of America: In November 2006, the stock was valued at $54.77; two and half years later, it crashed to a 20-year low of $3.79.
In the following 10 years, Bank of America picked itself up and grew spectacularly. The stock produced a ten bagger performance and reached a high of more than $35 in January 2020, delivering an 11-year return of 823%.
However, the coronavirus crisis hit the stock hard and it has fallen by 39% in a few short months.
Is the stock dead or do the fundamentals justify buying the dip?
With total loans of $983 billion dollars, Bank of America is one of the US’ leading banks and is still growing. In 2019, it grew its deposits by 5% and its loans by 7%. With Total Assets of $2.4 trillion and a current P/B Ratio of 0.73, Bank of America appears seriously undervalued.
Indeed, while its 2016-2019 revenues are only up 9%, its 2016-2019 net income is up 53%. This suggests that the bank is very effective at generating profits, which is verified by its 5-year average net margin of 25% and its efficiency ratio of 60.17%.
Also, Bank of America is generating massive cash flow: Its 2016-2019 Free Cash Flow increased 237%, going from $18.3 billion to $67.7 billion.
Two other positive aspects of the stock are the debt ratio of 0.891 and the Debt to Equity ratio of 8.19, which are the lowest of all the major American banks.
Lastly, the current dividend yield of 3.5% and a strong history of stock buybacks (which will be suspended for the foreseeable future) make Bank of America an attractive proposition.
With Total Assets of $895 billion and 2019 Revenues of $38.9 billion, Morgan Stanley (NYSE: MS) is a banking behemoth. Its businesses is split into three main units: Institutional Securities Group, which is their most profitable; Wealth management, which provides services to high net-worth individuals; and Investment management, which provides services to institutional and retail clients.
Like Bank of America, the stock got hammered in 2007, dropping 86% from $72.30 in July 2007 to $9.68 in October 2008. However, the bank recovered well and reached a price $57.51 in January 2020, which represents a 12-year capital gain of 494%, or 41% per year.
Like most stocks, the coronavirus caused the stock to fall 36% to reach a current price at writing of $36.61. Thus, with a current P/B ratio of 0.74, Morgan Stanley also appears undervalued.
From a financial perspective, Morgan Stanley is performing very well: Its 2016-2019 Revenues increased 18.99% and its 2016-2019 Net Income increased 54.5%.
Furthermore, its 2016-2019 Operating Cash Flow increased a whopping 1566%, going from $2.4 billion to $40.7 billion and its 2016-2019 Free Cash Flow increased an even more astonishing 3225%, going from $1.1 billion to $38.9 billion.
Evidently, business is good and the bank’s 2019 efficiency ratio of 72.7% is the highest of all the major banks.
Its Debt ratio of 0.907 and Debt to Equity ratio of 9.96 are nothing to worry about as they are in the same range as all other major American Banks.
Lastly, its TTM EPS of 5.19 and current dividend yield of 4% make it an attractive investment proposition.
Goldman Sachs (NYSE: GS) is an elite banking behemoth. Considered by some as “the bank who rules the world“, it has recently started branching out by offering financing and wealth management solutions to the general public. The release of the Apple Card and the launch of its Marcus high-yield savings and personal loan platform are two visible examples of their successful venture into the realm of consumer banking.
As most bank stocks, Goldman Sachs suffered greatly from the 2007-08 financial crisis, dropping almost 80% from $229.60 in November 2007 to a low of almost $50 in 2008. Since then, the stock reached $242 in January 2020, representing a total 12-year return of 79%.
Like most other bank stocks, the coronavirus caused the stock to drop 37% from its January 2020 high of $249.72 to the current price of $156.
With a current Price/Book ratio of 0.65 and EPS of 21.03, Goldman Sachs appears to be another undervalued bank with potentially significant upside.
Financially, Goldman Sachs is performing well. The bank’s 2016-2019 Revenues increased 18.68% and its new consumer banking sector performed even better, increasing 23% between 2018 and 2019. This impressive financial performance should continue as Goldman Sachs continues its diversification into auto loans and mortgages.
Also, Goldman Sachs’ 2016-2019 Operational Cash Flow increased 328%, going from $5.5 billion to $23.8 billion and its 2016-2019 Free Cash Flow increased 472.5%, going from $2.6 billion to $15.4 billion.
With a Current Ratio of 1.69 and a Debt Ratio of 0.909, Goldman Sachs’ assets cover its liabilities.
Lastly, the stock price presents an attractive dividend yield of 3.40%.
All three of these stocks appear undervalued and could be good long-term investments.
Investors interested by this sector should consider looking at these three stocks in more depth to take advantage of the recent coronavirus dip.
DISCLAIMER: This is not financial advice. Do your own research before investing in any asset.