uploads///Banks PBV

Are Wells Fargo’s Premium Valuations Unwarranted?

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Nov. 23 2016, Updated 11:04 a.m. ET

Wells Fargo’s valuations

Generally, banking stocks (XLF) trade between 1x and 2x their book values. Stocks trading lower than their book values attract investors’ attention because they’re considered to be generating extremely poor returns.

Price-to-book value (or PBV) compares a company’s current market price to its book value. This ratio is commonly used to compare financial services companies because most banks’ assets and liabilities are constantly valued at market values. If a company is trading lower than its book value, either its asset value is overstated or it’s generating a poor return on its assets.

Wells Fargo’s (WFC) book value has risen twice as much as JPMorgan Chase’s (JPM) and ten times as much as Bank of America’s (BAC) in the past ten years. It’s been one of the most profitable banks in the United States, generating a 1.3% return on its assets in 2015.

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However, risks resulting from its tarnished reputation and its loss of client confidence have hurt WFC in the last month. Wells Fargo’s shares are currently trading at a significant premium to its US peers such as JPMorgan Chase, Bank of America, and Citigroup. Such premium valuations are unwarranted for Wells Fargo, given the multiple downside risks it currently faces.

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