Good (Bad) Banks and Good (Bad) Investments: At the right price...

Following up on my last session, where I drew a contract between good and bed banks, in this one, I look at the contrast between a good banking investment and bad one, iwith banking pricing taking center stage. A good bank that you overpay for is a worse investment than a bad bank that you get at a bargain price. I look at intrinsic valuation in the context of a bank, arguing that you can only value equity (as opposed to operating assets or enterprise value) at a bank and then developing a model, based upon regulatory capital, to estimate free cash flows to equity. I also looking at pricing banks, noting the reasons why price to book ratios have deep roots in analyses, and compare banking price to book ratios across time and across the cross section. I close with a pricing of the 25 biggest US banks and disclose that I will be adding Citi, a bank trading at half its book value, a pricing discount that makes this stodgy, low growth bank into a good investment.

[deveshdembla]

Watching in September 2024, Citi is trading at $62. Thank you for making valuations so interesting.

[cecilia]

Thank you so much professor. Can't believe we get to see such high value educational content for free!

[cagrmercan]

i follow your blog for 1 year and its the greatest service i've ever seen. many thanks!!!

[MrShiva]

Sir, Please make the next video with a focus on banks with largest exposure to Commercial Real Estate. Most Pundits are predicting a commercial real estate bubble, a video will help a lot. Many thanks for sharing your wisdom

[hvglaser]

Dear aswath

For the 3D scatter plot, a colour gradient on one or two axes would make it easier to see where the data points belong on the depth scale

[Tential]

31:45 I think dividend yield should be dividend and buyback yield here. Jpm does it's full cash yield as dividend and buyback. Majority of the return is the buyback, not the dividend.

[nylesmclean]

Hey Aswath, I’m curious why you wouldn’t include Capital One ($COF) bank in your analysis? It seems like it’d be very attractive based on your metrics of choice

[imperfectpandaa]

Thank you sir for your insightful training videos. Sincerely appreciate for curating the content to cover latest developments.

[supertramp]

Thank you professor. you are my star, one day I will meet you and tell you this.

[oleksandrholovko]

Re 3-d graph -- I would like to suggest changing it to 2-d graph, while the third dimension is to visualise with bubble sizes. I guess the winners and losers would be visible more explicitly.

[chandrannatarajan]

Thank you Professor. Stay blessed always.🙏

[David.Marquez]

Thank you professor, how do you think this valuation model would change for neobanks that maybe involve themselves in a lot more fintech or brokerage services? Would there be a sum-of-parts there? Thank you.

[pabloespinosa]

Great content as always! Profesor Wouldn’t it be reasonable to think that net income will shrink given that: 1) banks have to make investment in digitalization to stay competitive without gaining new clients (this expense i imagine will only increase) 2) fintechs will be taking their lunch by aquiring their best clients and living the banks with higher non payable loans and the same rates. Also when calculating net income write off of bad loans doesn’t go through P&L, what we are considering in the calculation are provision wich are always higher and differ a lot from bank to bank. Shouldn’t we make some type of adjusment so we are not penalizing conservative bank for putting a high level of coverage on their provisions ?

[jayliu]

Is the interest spread in your slide mean the net interest margin? on slide 23, citigroup is 9.39%, that can not be right, JP morgan 6.8%? (may be including the fees revenue) Am I missing something? Thanks.

[sublyme]

Yay! 4 of the banks I'm invested in made the green P/B list! I have to confess I have no idea how to value a bank, but I know that many good banks are selling for bargain prices. If these turn out to be profitable in the years to come, I'll have to tip my hat to Lady Luck rather than my investment prowess. Thanks Aswath!

[himsincha]

Subscribed and liked for such valuable information.

[madhumitadas]

Very nice and informative video. Thanks for sharing this important video

[arielburbaickij]

Why actually to rush buying Citigroup on 09.05.2023, if their ex-dividend date was on 27.04.2023 and payment of dividends in the amount of 0.51$/share is scheduled to happen on 25.05.2023 ? So, to make it explicit -- one does not get dividends, if one buys on 09.05.2023 and if market is halfway rational, dividends are already priced in, and so share should drop by 0.51 on 26.05.2023 ? Any rationale for that ?

[hongkongnews]

Hello professor. When valuing banks, is it necessary to consider multiple business segments, such as trading and investment banking sectors? After all, income from these sectors is primarily affected by interest rates and overall economic conditions. I don't like these sectors, but I think they must have different costs of equity and reinvestment rates than the loan and deposit sectors. One example is the human capital-the giant salary and bonus banks pay to those investment bankers when the deal is booming.

[nihiraddla]

In the Citi model, shouldn't we subtract out dividends from net income to get FCFE. The motivation for this is that Citi is deploying capital in a value destructive manner, ROE < COE. However, the capital citi is redeploying in reality is net income - investments in regulatory capital - dividends paid out, not just net income - investments in regulatory capital. Woulnd't it make more sense to think of FCFE like this while discounting the dividends paid out at the COE and adding the pv of these dividends to equity value?