US Bancorp and PNC Financial are two of the top regional banks in the United States. But for many investors, there isn't enough room in the portfolio for two regional bank stocks, so a decision has to be made. If given the choice between the two, which stock represents the better investment today? Let's find out.
We'll start with valuation The crux of this decision starts with the dramatically different valuations the market has given these two banks. On a price-to-tangible book value basis, US Bancorp is one of the priciest bank stocks out there. It currently trades at 2.7 times its tangible book value. The average of comparably sized regional banks is 1.85.
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PNC, on the other hand, trades at a comparatively cheap 1.6 times tangible book value.
This huge discrepancy presents two questions: First, why is US Bancorp so much more expensive, and second, are we better off investing in the premium stock with less room to advance or going with the cheaper stock that seems to have greater upside?
Why is US Bancorp so much more expensive? The primary reason US Bancorp trades at such a premium valuation is that it has industry-leading earnings. While most of the industry is struggling to produce returns on equity at just 8% to 10%, US Bancorp turned in a 13.3% ROE in the second quarter.
PNC reported a middling 9% ROE, putting the bank squarely in the pack with the rest of the industry.
A lot of the reason for US Bancorp's outperformance is in the bank's excellent expense management. Using the efficiency ratio, we can compare the ratio of net revenue to non-interest expenses at banks. The lower the efficiency ratio, the more efficient the bank.
For the second quarter, US Bancorp's efficiency ratio was 53.2%. PNC's ratio was again in line with the peer-set average at 61%.
If it wasn't yet clear which of these two banks have the better operating numbers, we still need to touch on each bank's credit quality. Comparing the bank's ratio of severely past-due loans and foreclosures to its total assets, US Bancorp again beats PNC and the rest of the industry with a ratio of 0.4%.
The peer set average was 0.66%, and, once again, PNC lands nearly perfectly at that average with a ratio of 0.7%.
Buy premium or buy cheap? The decision boils down to a simple proposition.
You have US Bancorp, an exceptional bank. Its fundamentals are fantastic across the board, which has driven its price to a premium, expensive level.
Then you have PNC and its largely average numbers. It's cheap compared with US Bancorp, but its valuation is pretty close to average compared with other large regional banks. Average results yield an average valuation. Go figure.
We must decide whether US Bancorp has a better chance of maintaining its premium status over time than PNC has of elevating itself from average to high-performing. My personal view is that in the banking industry, history has a tendency to repeat itself. And in this case, history is on the side of US Bancorp.
Going back 25 years, US Bancorp has almost always traded at a higher premium than PNC.
And in terms of total returns, which include both share-price appreciation and dividends, US Bancorp has crushed PNC over that same period.
Based on that, my bet is that US Bancorp is the better long-term buy today, even though it's so much more expensive than PNC.
The article Better Buy Today: PNC Financial or U.S. Bancorp? originally appeared on Fool.com.
Jay Jenkins has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.