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Which Banks Look Attractive ahead of 3Q16 Earnings?

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Price-to-book ratios

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.

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Wells Fargo’s book value has grown twice that of JP Morgan and ten times that of Bank of America in the past ten years. It has been one of the most profitable banks in America, generating 1.3% return on assets in 2015. However, recent scandals have marred its reputation and might push its valuation lower.

Currently, Citigroup (C), Goldman Sachs (GS), and Bank of America (BAC) are trading below their book values. In comparison, J.P. Morgan (JPM) and Wells Fargo (WFC) trade at price-to-book ratios of 1.1x and 1.4x, respectively. Comparatively, Bank of America, Citigroup, and Goldman Sachs trade at PBV ratios of 0.66x, 0.64x, and 0.9x, respectively. This implies a discount of 34%, 36%, and 10% to their respective book values. Such cheap valuations are generally associated with a bank in crisis and are also a sign of the company’s poor profitability. However, if interest rates go up and trading activities pick up, profitability for these companies will improve, and they will have significant upside potential.

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