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Using the Price-to-Book Ratio to Value Bank Stocks

Motley Fool Staff, The Motley Fool

When looking at their P/E ratios, you may think the big four U.S. banks are trading for roughly the same valuation. However, the price-to-book and price-to-tangible-book metrics tell a different story.

In this clip from Industry Focus: Financials, host Shannon Jones and Fool.com contributor Matthew Frankel discuss the different ways to value bank stocks.

A full transcript follows the video.

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This video was recorded on July 9, 2018.

Shannon Jones: Matt, we've talked about the four big banks. Looking at it, three out of the four are doing well, winning where it matters most. You'd expect to see the market rewarding many of these bank stocks year-to-date, but it's actually been an interesting year. Can you talk a little bit more about that, and where these banks fall valuation-wise?

Matt Frankel: Like you said, all four of them have actually gone down for the year. JPMorgan (NYSE: JPM) is pretty flat, but the rest of them -- Bank of America (NYSE: BAC) lost 2%. Wells Fargo (NYSE: WFC) is down 6% this year, some of that could be because the Fed penalty I just mentioned was imposed in February. Citigroup's (NYSE: C) down 8%. A lot of that is due to their international exposure. These have not performed well. A lot of it is because they've performed so well over the last few years, in the lead up to tax reform, the lead up to rising interest rates. It's almost like all that was priced in a little bit, so that's why they've underperformed this year.

In terms of valuation, there are two things I'd like to highlight. One, the price to earnings multiple, while still useful, doesn't really tell you the whole story. For the most part, these banks trade in pretty much the same price to earnings range. Citigroup's a little cheaper, just because of the risk involved, but the rest are generally around 14-15X earnings.

The real thing you want to look at is book value. Banks generally trade at a multiple of their assets depending on how profitable they are. That's how you can tell what you're getting for your money, what kind of quality you're getting for your money. To put that in context, JPMorgan is the most highly valued of the four, trades for just about 1.6X its book value. Bank of America is 1.2X book value. Wells Fargo is actually almost as much as JPMorgan, 1.55X its book value, just because of its high asset quality that I mentioned earlier. Citigroup is actually trading for below its book value, if that tells you anything about the risk you're taking on by buying that stock, it's about 96% of its book value.

Then, you can even go a step further and look at what's called tangible book value, which only includes the assets that can be readily sold and you can really easily value. It excludes things like good will adjustments, things like that. Looking at it that way, Wells Fargo is actually the most expensive of the four at 2.1X its tangible book value, or 2.1X the value of its tangible assets on its balance sheet. Then it goes down from there. JPMorgan is 1.95X, Bank of America 1.75X its tangible book, and Citigroup is about 1.1X its tangible book. Big difference in those values that you really wouldn't see just by looking at the price to earnings multiple.

It's really important to take that extra step when looking at these bank stocks. Price to book and price to tangible book really give you a feel for how much investors are willing to pay for these banks' assets. How well they generate profit on them generally dictates how valuable they're going to be from price to book.

That's the metric you want to watch to see when it's a good time to buy.

Matthew Frankel owns shares of Bank of America. Shannon Jones has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.