Saw a research analyst talk about valuing banks using P/B relative to ROE. P/B makes sense as they hold more liquid assets but why relative to ROE?
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It is all about understanding what does equity mean for a bank. P/BV is one of the most useful metrics for financial institutions as Book Value is a fair proxy for what the bank is really worth. As to answer why ROE is less relevant than P/BV my take is that Equity value is quite variable due to its link to the price of assets - I do not want to address why, but has to do with the fact that assets for Financial Institutions are sometimes traded in the market. Another possibility: the regulatory constraints on financial institutions that force them to have certain minimum levels of equity.
ROE is still a widely used measure especially if you use the Excess returns model when you compare it to the cost of equity.
I am still quite novel to the FIG analysis so if someone can clarify or confirm what I just said it would also help me a lot.
Cheers!
In terms of looking at stocks from a research analyst prospective, P/B and ROE are usually pretty correlated. I mean it makes sense, both look at the equity for a company. But i've seen analyst reports where they run a regression for a list of comps based on their P/B relative to the ROE. If the company is below the regression line, usually mean it's undervalued. If they have a high P/B relative to the ROE, it means the numerator (Price) is high and suggests the stock expensive. They also use it to calculate a future Price target
So if I'm thinking about this correctly, it's measuring the price you are paying on a banks assets while also measuring the return on those assets. That makes sense, but why is this not a measure for other industries ie. P/E relative to ROE or something?
Its more of the relation of the book value per share from the P/B and its relationship to ROE's equation (N.I / Equity). Using P/E doesn't have a strong correlation because Earnings Per Share and Equity are different things. If that makes sense. Another example of a strong correlation would be P/S and NPM.
Banks are generally valued off of two key multiples, P/E and P/TBV (tangible book value). It’s debatable which one is ultimately the driving factor in market valuations, so we often will perform a regression analysis of current peer P/TBV trading levels against forward return on tangible commons equity (ROATCE) to link P/TBV to forward earnings. This works mathematically because ROATCE is simply net income over average TBV - so the TBV factor cancels out. We can then use this analysis to predict where a bank should trade given its ROATCE expectations and to determine if it is over- or under- valued relative to its peers.
This is correct. Profitability for a bank should drive valuation. Therefore, the higher the ROATCE, the higher the Price / TBV multiple should be. It analyzes the relationship of profitability to where / what your expected stock price should be since both are based on tangible book value. It also illustrates whether you are overvalued or undervalued relative to where other banks currently trade.
High Return on Equity, P/BV Ratio (Originally Posted: 04/04/2018)
Currently doing a valuation of a finance company (consumer leasing, interest free debt etc). All was going well until I noticed that my forecast P/BV is very low (0.8) with an ROE of 15%.
Maybe I'm just wiped, but isn't this unrealistic? It's essentially saying that for every dollar of equity in the company, the market is only willing to pay 0.80, when every dollar of equity is yielding 15%.
Would love if someone could explain this to me/why this is happening.
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