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US Financials - PB ratios matter
April 16, 2010

JP Morgan's latest earnings announcement has given financial stocks a shot in the arm. We relook valuations in the sector to assess its attractiveness.

Author : iFAST Research Team

Untitled Document
Chart 1: Increases in valuation the main driver of performance
Chart 2: 10.1% annual book value growth until October 2007

Key Points

  • JP Morgan’s better-than-expected earnings have given financial stocks a boost
  • Other major US banks are scheduled to report earnings over the next week
  • A relook at valuations shows that US financials currently trade at 1.33X book value, higher than in our previous updates (0.93X in Jul 09, 1.16X in Oct 09)
  • The strong returns of financial stocks can be attributed to the higher valuation multiples accorded by the market
  • Book (net asset) value has hardly grown since Mar 09 lows
  • Between May 93 and Oct 07, book value of US financials grew 10.1% annualised
  • Book value has since declined 32.1% from the peak in Oct 07 (as of Apr 10)
  • While there remains substantial scope for PB ratios to increase further, investors can look towards the growth of book value (net assets) as a function of future returns

JPM gives financial stocks a boost

Earnings season is underway again in the US, with financial sector bellwether JP Morgan Chase (JPM) reporting strong profits for the 1Q 10. JPM reported earnings-per-share (EPS) of US$0.74, 85% higher year-on-year and strongly ahead of the US$0.64 expected by the consensus. While JPM’s consumer lending and retail banking businesses continue to struggle, the lower credit loss provision for 1Q 10 (US$7.01 billion, down 21% quarter-on-quarter) is a strong indication that things are turning around.

In light of the better-than-expected results, the financial stocks were given a boost with the S&P 500 Financials index gaining 2.6% over the trading session (on 14 April 2010, in USD terms). Other major US banks are scheduled to report earnings over the next week (see Table 1), and their results will shed further light on the health of the US economy.

Table 1: Big Banks Reporting


Reporting 1Q 10 Results

Bank of America




Goldman Sachs


Wells Fargo


Morgan Stanley


Source: Various company reports

Time to relook valuations

US financial stocks (as represented by the S&P 500 Financials index) have risen 15.8% (in USD terms) since our last update (in October 2009), and it is probably time to relook valuations to see if the asset class still represents an attractive investment opportunity. As of 14 April 2010, US financials trade at a price-to-book (PB) ratio of 1.33X, which still represents a meaningful discount to the historical average of 2.1X (since 1993). However, we note that valuations have risen since our previous updates (0.93X in July 2009, 1.16X in October 2009), suggesting that there is less scope for upward revisions in the valuation multiple.

[As of 14 April 2010, global financial stocks (represented by the MSCI World Finance index) trade at a PB ratio of 1.24X]

Strong returns attributed to higher valuations

The strong performance of financial stocks since March 2009 can largely be attributed to the increasing PB valuation multiple that investors are willing to pay. As seen in Chart 1, the main driver of monthly performance of US financial stocks has been PB ratio increases. On the other hand, book value has not increased substantially since March 2009. In fact, book value of US financials has only risen a paltry 7.8% since the crisis-low (as of 14 April 2010).

Growth in book value to provide the next stage of returns

As chart 2 shows, book value of US financials grew by an annualised 10.1% between May 1993 and October 2007, before plummeting 32.1% to current levels (as of 14 April 2010). Much of the destruction of book value in the recent crisis was due to the huge write-downs and credit losses on bank assets, and to a certain extent, the issuance of new equity at distressed levels far below net asset value. The economic cycle has now turned and write-downs have fallen substantially. While banks continue to make provisions for credit losses, the return of profitability in the sector means that these institutions can begin to grow their book value once again.

As of 14 April 2010, the consensus now expects book value growth of 6.6%, 7.1% and 7.6% for US financials for 2010, 2011 and 2012 respectively, a 7.1% compounded annual rate of growth over the three years. At a PB ratio of 1.33X, US financials are not expensive and we expect that valuations still have considerable scope to increase further. However, in the unlikely event that the market fails to attribute higher valuations to the financial sector, investors can look towards the growth of book value as a driver of future returns.


related articles:

Global Financials to drive the new bull market

iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.


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