As many already know, the recent scandal with Wells Fargo's (NYSE:WFC) account setups has hit the stock price quite harshly in the recent weeks. This news along with a lot of the Fed's decisions and presumptuous interest rate increases in the near future attract some investors to position their portfolios with some exposure to the financial services industry. Although I will not be talking specifically about the Wells Fargo incident, the recent valuations have sparked my interest to write about the industry.
In this piece, I provide a relative and consensus analysis among many of the well-known large cap U.S. banks and financial services companies. These names include Wells Fargo, Bank of America (NYSE:BAC), JPMorgan (NYSE:JPM), U.S. Bancorp (NYSE:USB), PNC Financial (NYSE:PNC), Citigroup (NYSE:C), SunTrust (NYSE:STI), Morgan Stanley (NYSE:MS), Goldman Sachs (NYSE:GS), BB&T (NYSE:BBT), and Fifth Third (NASDAQ:FITB). Although the companies most likely trade at different valuations given their focus on business, size of operations, and geographic exposure, the consensus' forward valuations help to make the valuations more comparable purely based on future growth prospects.
From the tables, there are many comparative areas of growth and valuation that can be interpreted. I will trying to pick out some of the interesting comparisons and my thoughts.
I noticed on a trailing basis that Wells Fargo and JPMorgan are trading at very close valuations at the 11x earnings mark. When viewing the earnings growth potential in the next two years, the street consensus feels that JPM has an edge over WFC (3.8% vs. 2.0%), suggesting it will outperform in the future. Based on historical P/E multiples, WFC has always traded higher than JPM since 2008 (with the exception of 2013) and the valuations are crossing paths again. On a book value basis, Wells Fargo is still trading at a premium to JPMorgan and the entire peer set. This premium book valuation may be warranted given the high estimated ROE in forward periods relative to peers.
Similar to the PEG method of understanding the relationship between P/E and earnings, I believe that there is a relationship between P/B and ROE. For instance, if a financial services company has a P/B of 1x, then I feel that the ROE should be at least 10% to justify the valuation. At the same time, if a company had a P/B of 0.8x, then an 8% ROE would justify it. Based on this P/B-ROE relationship, companies such as WFC, C and JPM trade fairly, FITB may be undervalued and the rest may be overvalued.
Although BAC would be thought of to be comparable to WFC, JPM and C, it appears that its trailing earnings valuations and earnings growth profile isn't more in tune with MS, GS and BBT. Noticeably, the high forward earnings growth suggests that this premium P/E is justified when comparing to the total peer set. However, amongst the four companies (BAC, MS,GS, BBT), it appears that BBT might overvalued by the fact that it is the slowest grower and trades at an equally high valuation near the 15x earnings level.
In terms of the rest of the peer set (excluding BAC, MS, GS and BBT), I found that Citigroup appears to be undervalued in the sense that it has a higher expected growth rate and a lower trailing earnings valuation. In the coming two years, Citigroup's earnings are expected to grow at 8.5% versus 2% by its peers while its trailing P/E is 10.4x versus the 11.3x group median.
When viewing the historical multiples data, the peer set appears to be quite stable when speaking about P/B. The group median has quite successfully maintained a 1.1x book multiple for the past 3 years. In terms of an earnings basis, the companies have been a bit more volatile and vary within a tighter range in the past 3 years at around 12-14x. Although there is not an indentifiable upward trend in these data points, I believe that there is the opportunity for a wider industry multiple expansion in the future from the expected increases in interest rates.
(Source: Morningstar, ThomsonOne)
In summary, on a high level, the comparative analysis I have done only considers their expected growth and valuation, which in definition is more interesting for GARP investors. My piece does not consider many aspects of maybe why some companies tend to trade at valuations outside their growth profile such as competitive advantages, M&A, dividend payouts, management teams, debt management, etc. The reader is recommended to do further due diligence on the individual companies.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I used to have a position in WFC.