Must-know: Putting the price–to-book value ratio in perspective

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Must-know: Understanding the price-to-book value ratio (Part 6 of 6)

(Continued from Part 5)

Overview

We explored the most commonly used valuation metric for financial companies—the price-book value. Most analysts on the Wall Street often use this ratio to analyse traditional banks like Wells Fargo (WFC), investment banks like Goldman Sachs (GS) and Morgan Stanley (MS), full service banks like JP Morgan (JPM) or any other financial companies included in an ETF like Financial Sel Sect SPDR FD (XLF). We also understood the relation between price-book value and return on equity. We used the learnings to know how to select companies. We also looked at the pitfalls of using this metric and how to avoid these traps.

Other metrics

There are many other metrics that are important for analyzing financials. Metrics like market share of assets (see the chart above) and deposits, capitalization, cost-income ratio, and net interest margin are all important when analyzing financials. We’ll take an in depth look at these metrics in our subsequent series.

Word of caution

Finally, we’d like to give you a word of caution. We all would love to have a system that is foolproof and that always work. But investing has no silver bullet. Approach any metric with caution and circumspection. Stay clear of the pitfalls we have outlined in the previous parts of this series. Use a combination of metrics to arrive at a conclusion. But if you find that the stock that you analyzed fulfills your own investment criteria, then do go ahead and invest. If you’re an investor who doesn’t have the time or the appetite to analyze companies, you can benefit from investing in financial companies’ exchange-traded funds. If you want to know more about the banking sector, then you must read our overview of the sector here.

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