As earnings season gets under way again, bank stocks are in focus.
On Wednesday, analysts at Berenberg announced a series of new ratings for six of Wall Street's biggest banks. As the analyst explained, half the banks the analyst discussed merited only neutral ratings, and we won't discuss them further here (but you can find all six ratings described on StreetInsider.com).
In three separate cases, however, Berenberg saw enough of a disconnect between what a bank stock is worth, and what it currently costs to own it on the stock market, to convince the analyst to lay down a buy or sell rating. These are the ratings we'll be discussing today, as Berenberg lays out the cases for and against Bank of America (NYSE:BAC), Citigroup (NYSE:C), and JPMorgan Chase (NYSE:JPM).
Here's what you need to know.
1. Buy Bank of America?
It's good news for Bank of America this week, which Berenberg describes as "a lower risk franchise than many perceive."
With all of Bank of America currently valued at less than 60% of its book value, investors appear to perceive quite a lot of risk in owning Bank of America stock. Yet Berenberg finds quite a lot to like. For one thing, while most analysts who follow Bank of America see the stock growing earnings at a below-industry rate of just 6% (according to estimates collected by S&P Global Market Intelligence), Berenberg thinks it's more important to focus on the amount of capital B of A is returning to shareholders through a combination of its 1.5% dividend yield and its share repurchase program.
Berenberg estimates the total value of such capital return at 10% annually over the next five years, and views this as an attractive turn relative to the stock's 10.8 P/E ratio.
2. Or buy Citigroup instead?
Citigroup stock is next on Berenberg's buy list, and again we're looking at a stock valued at roughly 0.6 times book -- but at a P/E ratio of less than 9.
Relative to Bank of America, the cheaper valuation of Citigroup stock may be a fact explained best by analysts' expectation of even slower growth at Citi (5%) than at B of A (6%). And yet, once again, Berenberg believes that investors are missing the trees and focusing too much on how slowly the forest is growing.
Capital returns are once again the name of the game, says Berenberg, and the analyst sees Citi, too, generating capital returns of about 10% per annum. (Unless Citi hikes its meager 0.5% dividend yield substantially, though, that return will need to depend more heavily on stock buybacks.)
3. But what about JPMorgan?
Meanwhile, whether measured by P/E or even more so when measured by price-to-book value, JPMorgan stock continues to sell at a premium to its rivals. The stock costs 11 times trailing earnings, and sells for a price-to-book value of nearly 1.1 -- almost twice the valuation accorded to Bank of America stock, or to Citigroup. If you ask Berenberg, though, this makes no sense: "We struggle to understand why JPM trades at a premium to peers, when historical and forecast losses imply it underperforms them."
Of course, JPMorgan reported strong earnings this morning, which suggests all those other analysts that Berenberg criticized in yesterday's rating may have known something it did not. Nevertheless, these same analysts forecast only a 5% earnings growth rate for JPMorgan (identical to Citi's forecast, and slower growth than B of A is expected to achieve). Given that JP isn't expected to outperform its rivals, Berenberg says the stock should really cost no more than the value of its "tangible book value," or TBV.
What's that worth?
Now, in contrast to ordinary book value, tangible book value isn't a metric easily searchable on most free financial data sites. Fortunately, S&P Global has the figures right at hand. According to S&P, JPMorgan currently sells for 1.4 times TBV, while Bank of America costs just 0.8 times TBV and Citigroup stock sells for a mere 0.7 times TBV.
By Berenberg's logic, therefore, if all three of these big bank stocks ultimately revert to their respective means, and sell for prices resembling the value of their hard assets, then JPMorgan stock is doomed to fall in price substantially. Indeed, JPMorgan could lose perhaps 29% of its value over time. In contrast, Bank of America stock should eventually trade as much as 25% above what it costs today, and Citigroup -- 43% higher! And that's the basis for Berenberg's ratings this week: Buy Bank of America and Citigroup, but sell JPMorgan Chase.
How likely is it that Berenberg is right about all this? Check out its record on Motley Fool CAPS and find out.