Mixed outlook for banking stocks
Rising interest rates are becoming a burden for the banks in light of the looming recession. It is true that the large financial institutions are outperforming the broader market. But investing takes a lot of courage. The price-to-book ratio can help with the choice
The country’s four most important economic institutes presented their annual autumn report today, Thursday. The grim forecast: Germany will slide into recession over the winter. In the US too, the Fed’s unusually large interest rate hikes are raising fears of a painful downturn. Big banks on both sides of the Atlantic are responding by increasing provisions for loan losses and limiting lending in risk categories.
The current situation means two things for the banks: Basically, rising interest rates increase their profits. On the other hand, rising interest rates, especially in combination with fears of recession, means that companies and consumers take out less credit. In the longer term, however, the growth in the core lending volume has an enormous influence on the financial institutions’ earnings situation. In other words, with weakened credit growth, banks ultimately benefit less from rising interest rates.
What speaks for the financial institutions: Today they are better equipped to handle an economic downturn than they were during the financial crisis in 2008. Their core capital ratios are significantly higher. Anyone who is aware of the uncertain situation and wants to focus on the banking sector will still find relatively good entry opportunities.
ratio between price and book
When looking for low valuations, many investors first look at the price-to-earnings (P/E) ratio. The metric compares a stock’s market price to an earnings number and measures the number of years it would take the company to earn its current stock market value. Basically the following applies: The lower the P/E figure, the cheaper and therefore more attractive the respective share is compared to the industry competition.
There is another metric that comes in handy when it comes to bank stocks – the price-to-book (P/B) ratio. KBV does not use a profit figure, but the book value of the balance sheet. The book value is the institute’s equity. For banks, the amount of equity capital is crucial to being allowed to take risky transactions on their books. Equity is therefore part of the basic equipment of every bank and is therefore an important evaluation indicator.
If the PBV is exactly 1, the company is worth as much as its assets on the stock market. For industries with high intangible assets but low book value, such as technology companies, the P/E is significantly higher. In contrast, the banking sector typically moves close to 1. When comparing two banks, the lower the P/B, the cheaper.
European banks lag behind
With total assets of more than $3 trillion, JP Morgan Chase is not only the largest bank in the United States. Based on forecasts for the current financial year, the share has a price-earnings ratio of 10. The corresponding KBV is 1.20. It is quite expensive for a bank. The second largest bank in the US, Bank of America (BofA), also has a P/E ratio of around 10 (2022e). However, based on their P/B of 1, the shares are cheaply valued.
European banks have struggled at a valuation discount compared to their US peers for decades. The P/B of most European financial institutions is well below 1. The British HSBC, one of the leading banking groups in the world, has a P/E of 8 and a P/B of 0.58 (both 2022e) . Deutsche Bank securities are even cheaper. The largest bank in Germany has an extremely low PER of 5 and a PB of only 0.27 (both 2022e).
As tempting as these figures may seem, investors should not only focus on a particularly low valuation, but choose a middle ground between an attractive key figure and the institution’s prospects for operating earnings. American institutes tend to be the better choice here.
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