I recently took some high level data from the companies covered in the
Value Line Investment Survey (both the Standard edition and the Small
and Mid-Cap edition) and decided to plot it out to see how bank
valuations have flexed over the last several years. All data is
courtesy of ValueLine (from 2003-2011) and all plots were made
with ggplot and
R. This isn’t the most rigorous of analysis,
but it was pretty useful for some projects I’m working on. Since this
only analyzes banks that are currently in the survey, it suffers
from survivorship bias. Given the state of the banking sector today
and its recent history, this is an issue.
The first graph charts Price to Book versus Returns on Equity for all
the banks in the survey. I’ve stratified out the banks by large cap,
midcap, and smallcap.
You can see that there are a large number of companies that trade
above or below the trend line, but the trend is pretty strong
regardless of market cap size.
Next we look at Price to Book versus Returns on Equity by year.
Again, the trend is very apparent, but the slope of the effect is
diminished as valuations get compressed post-crisis. You can see that as we went through the financial crisis, the
market began paying less of a premium for superior performance. As
investors became less trusting of bank balance sheets, they started
discounting the price. The idea of paying 4x book value for a bank
is laughable today, but in 2003 or 2004 seemed entirely rational.
The next chart is a histogram of Price to Book by year.
This gives you a good sense of the intense clustering of value in the
banking industry. In short, regardless of capabilities, most banks
trade the same today on a multiple basis. This could mean there are opportunities for
savvy investors to play a long-short strategy effectively here.
As further evidence of this, check out a boxplot of Price to Book
values by year, stratified out by small, mid, and large cap. Not only
have the standard deviations compressed, but so have the number of outliers.
Finally, let’s see how much ROEs have flexed through the crisis.
Couple of interesting points to make here. First, large caps seem to
have a better ROE performance than midcaps and smallcaps as evidenced
by the tighter variation and higher median. ROEs ranged in the
mid-teens for all banks in the 2003-2005 range and then large caps
really outperformed in 2006. 2007 was the year when write-downs and
capital impairments began to surface and you see the deviations of all
market cap sizes explode and by 2008 you begin to see the large cap
banks coming to grip with reality before everyone else and take huge
writedowns. The 2009-2011 period looks like the beginning of a return
to normal performance. If you believe in the loan quality of the
banks, they would be a steal here. Obviously, the Street doesn’t
agree with that assessment.