Much of the 2016 stock market downfall began with banks. Pressure percolated as European financial markets tumbled to multi year lows as commodity exposure became a concern.
American banks had moved higher since the financial crisis lows but barely above the halfway mark of the drastic drop. Though the general market recovered to rally back and make new highs, financials have been caught fighting the last war.
Price to earnings ratios in the major US institutions hover modestly around the double digit level. That low price in relative terms has some banks trading below book value.
Book is the balance sheet value from assets minus liabilities. Factories, building and cash show what a company is actually worth.
Stocks often trade at a premium to the cash out number with patents and intellectual property nearly impossible to price.
That pricing of assets was a contributor to the 2008 unwinding as many bank assets were illiquid and only worth a fraction of what was thought.
Acknowledgment of mispricing is reflected by corporate write downs.
A stock price below book value doesn’t mean it is undervalued and must go higher. That is just one possibility.
Recent news headliners Bank of America and Duetsche Bank are currently at less than half their book value.
Low interest rates moving even lower squeezes bank profits. Money is made on the interest spread between the borrow rate compared to their lending rate.
First quarter earnings in US banks saw estimates bested with a total quarterly profit in BAC, C, WFC and JPM totaling 18 billion dollars. As much as share prices have suffered, the money machine is running in high gear.
So to summarize, stock value lower than book doesn’t mean something is cheap.
Two things can happen to bring back balance:
• Share prices appreciate to reflect asset values
• A write down of assets reduces the balance sheet value
Free money is hard to come by for investors. Don’t be overly enamored with stocks trading at a discount to book value.
Remember, book value is just one metric to measure what a stock could be worth. The market tells us what it’s worth at that moment.
