How Cheap Are U.S. Bank Stocks?

How cheap are US banks? Recent price action suggests that market's answer to this is "rather." Merrill reports worse than expected (albeit only slightly worse than leaked), and the stock rallies 4% on the day. Today, Citigroup disappointed the consensus and wrote down $15 billion or so. However, this amount was less than the $22 billion leaked yesterday, and de-emphasized in the headlines. (Citi must have bunged Bloomberg's headline writer a few bucks, as the only "red headline" showed a $6 billion writedown.)

The BKX has struggled to break new lows, and Macro Man's favourite technical analyst is lookinbg for a tasty (albeit corrective) bounce in the index.
Macro Man decided to do a crude study of bank valuation. The study was not meant to be exhaustive, and he is well aware of the limitations of his metrics. He constructed an evenly-weighted (i.e., not cap-weighted) basket of a number of US banks- Citigroup, BofA, Goldman, Merrill, Morgan Stanley, and Lehman. Using Bloomberg data, he had a look at how the equally-weighted index of their prices and price/book ratios have changed over the last dozen years:
On the face of it, these stocks look pretty darned cheap. The price index is back at the level of four years ago, and the price/book ratio is at its lowest in the dozen-year sample. On this basis, they look like a scoop, plain and simple. Of course, things are never that simple. Price/book estimates for banks are notoriously unreliable, and the wedge between price and price/book means that book value has spared over the years. Perhaps we'd better look at that.
Oh dear. Book value has risen in a pretty straight line for the entirety of the sample, albeit with a modest downturn recently. When you consider the utter implosion of most banks' assets, and that some are realizing the losses at 90c on the dollar, it's difficult to believe that these book values have troughed.
Indeed, book values have only retrenched back to the levels of last March....which was only three months before the onset of the financial crisis. Now, maybe this is accurate, and that somehow banks have managed to defend book values even as they de-leverage their balance sheets. Then again, maybe not......

Macro Man will let you be the judge....

Comments

[Eric Fox:]

Where did you get your price to book values from? The bank sector was trading at more than 2 times book just a few years ago, but you have the peak at only 1.25.

2008 Apr 18 11:54 AM

[BSCLossMan:]

I'm no expert, but I look at the 2007 highs in bank/brokerage stocks as false highs based on voodoo securities. So to say C, for example, is about 50% off its high does not mean that it is cheap and will rise to those levels for a long time. With earnings very questionable going forward, book value almost a meaningless number, and write-offs every quarter (depending on what the bank wants to divulge), a still huge housing problem, I just cannot believe why people keep buying these stocks. The more they cut earnings and the more voodoo securities they admit to (& write down), the higher their stocks go. Other, non-financial stocks, miss earnings estimates by a cent, and their stocks get hammered. To me, a non expert, there is no sense to it.

2008 Apr 18 12:38 PM

[Kostya Tszy...:]

Commercial banks will make money the old fashioned way - increase spreads and lower the bank burden through technology and economies of scale.
I love the financials @ these prices...however let it be said, I've been wrong before.

2008 Apr 18 01:25 PM

[johnthebear:]

The thing that has not been factored into the value of C mer leh etc is that there is no future income in the bundle business. No more huge fees. That line of works is gone. Transparancy is the name of the game for the future, even for hedge funds! Banks will go back to looking at lower L/V ratios.

And leveraged buyouts...forget it, can't be done like in the old days. It is a different world out there. Remember how many have lost their jobs at each of the investment banks? They are no longer needed. The income they would have produced is forever gone! So, are banks really all that cheap? I doubt it. Everyone is looking in a rear view mirrror, instead of looking down the road, but even those that do, not beyond the end of their nose!

2008 Apr 18 01:36 PM

[damienhaas:]

Agree with all comments, it is earning that counts in the future, not book value.

2008 Apr 18 10:20 PM

[venividivici:]

Kostya Tszku I think you have taken one too many punches mate,
I hear you're making a comeback and I think that's a wise move. I'd stick to boxing mate

2008 Apr 19 12:27 AM

[Kostya Tszy...:]

Ouch, Veni. Glad you know me but sorry you missed the gains this week, however, there's more to come next week. Best of luck.

2008 Apr 19 03:33 PM

[Vegasjoe:]

Big banks are toast; earnings compression will keep prices down, and valuations will be lower too for financial assets. Lots of consolidation and mergers in next 24 months.

2008 Apr 19 07:52 PM

[low:]

You know, it's a funny thing. I recently read an article accusing the Fed of manupilating the market. And it caused me to venture that the bigger banks could do the same if they so desired. Right now it would seem that we're all getting a golden opportunity to view the glogal markets based on a more accurate snapshot.

Personally I have concluded it better to invest in the bank itself when you can find one trading in your price range. Though their holdings and recommendations can be impressive. But as we are seeing, more Custers show up to save the day for banks themselves. Tried offshore, worked out pretty well. Think I'll be heading back that way when the money's back up. Probably should have jumped on Bear Sterns when I had the chance but what can I say? Guess I just didn't believe that manna still falls from Heaven!

2008 Apr 20 03:17 PM