When picking a stock to buy, one of the first things an investor should look at is valuation. With bank stocks in particular, this means looking at the price-to-book-value ratio.
This is a metric that compares how much a bank claims to be worth on its balance sheet (on a per-share basis) to how much investors think it's worth, which is reflected in the bank's share price. To calculate the price-to-book-value ratio, you divide a bank's share price by its book value per share. A bank stock that trades for more than book value is said to trade at a premium; one that trades for less than book value is said to trade at a discount.
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The average bank stock on the KBW Bank Index, which tracks the shares of two dozen large-cap banks, trades for 1.5 times book value, according to YCharts.com. Getting a little more granular, 20 of the 24 stocks on the index trade at a premium to book value. The remaining four, listed in the table below, are priced below book value:
For investors looking for bargains among bank stocks, these four banks are a good jumping-off point. That said, as their low valuations intimate, they give investors reasons to be cautious.
Take New York Community Bancorp as an example. The New York-based bank has seen its share price fall 12.5% over the past year, after the bank slashed its dividend and ratcheted up expenses in order to consummate a merger, which was eventually abandoned. To make matters worse, this performance came at a time when other bank stocks soared -- on hopes that policymakers in the nation's capital would cut taxes and ease the costly regulatory burden on the bank industry, neither of which have yet to come to fruition.
Citigroup offers a similar cautionary tale. It's the fourth-biggest bank in the country and one of the oldest, but it's also one of the riskiest. Thanks to Citigroup's business model, with operations stretched around the globe, it faces more risks -- as well as more complex risks -- than banks focused on domestic customers. This is reflected in the bank's performance through the financial crisis, which would have caused it to fail but for U.S. government assistance.
Capital One Financial is in a different category. It started life in the mid-1990s as a monoline credit card company, before building a more traditional regional bank by acquiring the likes of Hibernia National Bank in 2005 and North Fork Bank in 2006. But Capital One's loan portfolio is still heavily concentrated in credit cards, which are the riskiest type of loans banks make. This risk, it seems, is being reflected in Capital One's low valuation.
Finally, Citizens Financial Group is the newest independent member of the list, being spun off from The Royal Bank of Scotland Group only three years ago. The regional bank, based in Providence, Rhode Island, has made considerable progress since then, with an efficiency ratio of 59.4 in the latest quarter. Citizens Financial's still modest profitability seems to be the culprit behind its inclusion on a list of big banks that trade below book value.
Ultimately, valuation is a starting place for investors, who should then dig further into a company before they buy its stock. Holding all else equal, however, a bank stock with a low valuation offers more upside than a bank stock with a high valuation.
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