With the recent auction of Treasury's Bank of America
The financial roller coaster ride of the past few years makes putting a price tag on bank stocks very difficult. Bank of America lost money over 2009, which makes valuation a bet on future performance.
One approach is valuing the bank based on what it might earn in good times. This analysis will apply recent high return on equity (ROE) values to common equity at the end of 2009 to see how Bank of America stacks up to the competition.
For each bank, recent high ROE was applied to current common equity to obtain an earnings estimate. That estimate was used to calculate a price-to-earnings multiple based on current share price and future earnings potential. Foolish readers will notice that this doesn't give any indication of when or if the bank might reach this pot of gold at the end of the rainbow.
|
ROE (2009) |
P/E (TTM) |
Recent Peak ROE |
Potential Future P/E |
|
|---|---|---|---|---|
|
Bank of America |
Not meaningful |
Negative |
18.1% (2006) |
4.8 |
|
JPMorgan Chase |
6% |
19.1 |
12.5% (2007) |
8.7 |
|
Wells Fargo |
9.3% |
16.6 |
19.5% (2006) |
7.5 |
|
Citigroup |
Not meaningful |
Negative |
18% (2005) |
3.6 |
*Sources: Capital IQ, a division of Standard & Poor's, and author's calculations. TTM = trailing 12 months.
The results show that the market is behaving with some efficiency. Based on potential earnings using recent peak returns, Bank of America trades at a discount to JP Morgan and Wells Fargo, and at a premium to Citigroup. That ranking makes sense, since Bank of America has more risk of not making it to normalized earnings than the two banks actually reporting profits, but not as far to go as Citigroup.
Fools also need to consider that these banks may take years to get back to high return levels, if indeed they ever do. New government regulations, less tolerance for risky lending, and a slower-than-expected recovery are just some of the pitfalls on the path to profits. The common equity value will also fluctuate based on the banks' operations.
In this Fool's opinion, those risks outweigh the apparent cheap valuation for Bank of America.
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