The Motley Fool Previous Page

3 Smart Ways to Invest in Bank Stocks

John Grgurich
February 11, 2013

There's more than one way to skin a cat, the saying goes. Likewise, when you're thinking of investing in a bank, there's more than one way to size it up.

Here's a rundown on three of the things I look for when buying into a bank -- a blend of basics you would look for in any kind of company you're thinking of investing in, as well as metrics that apply specifically to banking.

1. Valuation
When talking about valuation as it relates to a bank, you're talking about price-to-book ratio, or P/B. P/B compares a stock's market value to its book value. P/B is calculated by taking the market capitalization and dividing it by total assets minus total liabilities.

(The good news is, you can usually find this ratio calculated for you already on your favorite financial data website, which for me is Yahoo! Finance. Go to Key Statistics, and you'll find it seven lines down from the top.)

Investors generally look at P/B to try and determine if a stock is undervalued, and therefore might be a value investment. P/B also gives you some idea of whether you're paying too much for what would be left if the bank went, well, bankrupt immediately. For banks, a good rule of thumb is to try to buy under 1 times book value and sell above 2 times book value.

As an example, Bank of America (NYSE: BAC) is trading right now with a P/B of 0.58. That's very low. This could indicate the stock is undervalued and is therefore a great buy, or it could mean there's something fundamentally wrong with the bank itself, keeping the valuation low.

I'm personally bearish on B of A; I still don't believe the superbank has exercised all its financial-crisis demons. So for me, a book value of 0.58 is a big red flag rather than a big green light. It's one number, but there are different ways of interpreting it, which is why it's never good to rely on just one indicator when thinking about investing in any company.

2. Who's in charge
This metric, if you want to even call it that, is far more squishy than P/B, but to me is possibly the most important of all. The person at the top can make or break an organization. CEOs set the pace for any company, and give it its focus, direction, and culture. I look for a firm hand, coupled with an open mind, a penchant for straight talk, and at least a dash of humility.

An example of a bank I'm invested in primarily because of its leadership is JPMorgan Chase (NYSE: JPM). CEO Jamie Dimon gave such a strong performance in 2012, guiding the bank expertly and with humility through the terrible London Whale crisis, that when I bought shares, I essentially felt I was buying stock