Generally, banking stocks (XLF) trade between 1x and 2x their book values. Stocks trading lower than their book values attract investor attention because they’re considered to be generating extremely poor returns. The PBV (price-to-book value) compares a company’s current market price to its book value. These ratios are commonly used to compare financial services firms because most banks’ assets and liabilities are constantly valued at market values. If a company trades lower than its book value, it means that either the asset value is overstated or the company is generating a poor return on its assets.
Wells Fargo trades at a premium to Bank of America
Wells Fargo’s (WFC) book value has grown twice as much as JPMorgan Chase (JPM) and ten times more than Bank of America (BAC) in the past ten years. It has been one of the most profitable banks in the US. It generated a 1.3% return on assets in 2015. The fact that it relies less on investment banking and trading activities makes it less risky in the current conditions. Interest rate hikes could act as a positive catalyst to its earnings.
Currently, Wells Fargo trades at a premium to its peers in the banking space. In comparison, Bank of America trades at extremely inexpensive valuations.
Bank of America trades at a PBV of 0.62x. This implies a discount of ~38% to its book value. In comparison, JPMorgan Chase, Wells Fargo, and Goldman Sachs (GS) are trading at PBVs of 1.05x, 1.48x, and 0.86x, respectively.
Such cheap valuations are associated with banks in crisis. They’re also signs of a company’s poor profitability. In 2015, Bank of America generated a return on assets of 0.74%. This was lower than its target of 1%. It generated $15.9 billion in profits. In 1Q16, Bank of America generated a return on assets of 0.5%. Its earnings were hit by weak trading and investment banking revenue. If interest rates go up, Bank of America’s profitability will likely improve. The stock has significant upside potential.