Valuation
The nice thing about bank valuations is that we have a fairly objective way of quantifying intrinsic value – tangible book value. Which means that not only can we get a sense of how undervalued a bank is at the moment, but we can also get a sense for how the market is valuing the quality of a bank based on the premium or discount to tangible book value, both relative to a bank’s median historical value and in comparison to other global banks.
In this case, Goldman Sachs is trading at right around intrinsic value and a steep discount to its historical norms. This makes sense given the difficulties that investment banks are likely to have raising their margins in this new, higher regulation world.
| Bank | Price / Tangible Book Value (P/TBV) | 13 Year Median P/TBV | % Of Global Banks With Lower P/TBV |
| Goldman Sachs | 1.01 | 1.84 | 43% |
| Morgan Stanley | 1.07 | 1.76 | 45% |
| Citigroup | 0.79 | 3.06 | 28% |
| Bank Of America | 1.02 | 2.67 | 40% |
| JPMorgan Chase | 1.44 | 2.20 | 36% |
Source: Gurufocus
In other words, Goldman’s price to tangible book value (P/TBV) may never again rise to its usual premium valuation, effectively capping its potential for capital gains. Combined with the second lowest yield of its peer group and the penchant for going years between raising its payout, this makes the stock, in my opinion, a far less attractive dividend growth investment than most of its rivals.
For example, Bank of America and Citigroup, both previously deeply troubled megabanks, are trading at the largest discounts to their historical norms. For Citigroup, I believe this is justified but possibly not so much for Bank of America given CEO Brian Moynihan’s ongoing cost cutting measures, rigid high lending standards, and industry best potential to profit from rising interest rates.
As for JPMorgan Chase, its premium valuation relative to its peers is justified by its world class leadership under Jamie Dimon, whose conservative approach to banking allowed the company to not just survive the financial crisis intact but also maintain profitability. JPMorgan was even helping the US Treasury stabilize the financial industry with its acquisition of failed retail bank Washington Mutual, thus coming out of the crisis larger and stronger than ever.
Conclusion
Dividend investors interested in owning banks, whether retail, investment, or a hybrid of the two, always need to keep in mind that this sector is prone to higher risk, courtesy of both more stringent regulations as well as the risk that derivatives on the balance sheet make their balance sheets “black boxes”.
In the case of Goldman Sachs Group Inc (NYSE:GS), despite its leading position in investment banking, I think there are better options investors should consider. That’s due to Goldman Sachs’ lower potential profitability, more cyclical sales, earnings, and cash flows, and lower potential to benefit from rising interest rates in the coming years.
Meanwhile, JPMorgan Chase arguably represents the “best in breed” of hybrid banks, thanks to a conservative banking culture instilled by CEO Jamie Dimon that should allow it to easily survive even the most challenging future economic or financial calamities.
Regardless, investors should approach bank stocks with conservatism. Some of them appear to be high quality businesses with above average dividend growth prospects, but most fall in the “too hard” bucket for me. I’ll stick to my other favorite blue chip dividend stocks (3) for now.
Disclosure: None
Additional Links:
(1) http://www.simplysafedividends.com/top-dividend-stocks/
(2) http://www.simplysafedividends.com/top-10-financial-ratios-dividend-investing/
(3) http://www.simplysafedividends.com/blue-chip-dividend-stocks/
