𝗪𝗵𝘆 𝗶𝘀 𝗣/𝗕 𝗮 𝗯𝗲𝘁𝘁𝗲𝗿 𝘃𝗮𝗹𝘂𝗮𝘁𝗶𝗼𝗻 𝗺𝗲𝘁𝗿𝗶𝗰 𝘁𝗵𝗮𝗻 𝗣/𝗘 𝗳𝗼𝗿 𝗕𝗮𝗻𝗸𝘀?

P = Price = Market Value of Equity
B = Book Value = Book Value of Equity

Book Value of Equity = Assets (loans given out) – Liabilities (deposits)
i.e., Book Value of Equity = Net Assets

P/B compares a bank’s market value (price) to its book value (net assets)

𝟯 𝗸𝗲𝘆 𝗿𝗲𝗮𝘀𝗼𝗻𝘀 why P/B is a more reliable metric than P/E:

𝗮. 𝗕𝗮𝗻𝗸’𝘀 𝗯𝗼𝗼𝗸 𝘃𝗮𝗹𝘂𝗲 𝗿𝗲𝗳𝗹𝗲𝗰𝘁𝘀 𝘁𝗵𝗲 𝗿𝗲𝗮𝗹 𝘃𝗮𝗹𝘂𝗲 𝗼𝗳 𝗻𝗲𝘁 𝗮𝘀𝘀𝗲𝘁𝘀 𝘄𝗵𝗲𝗻 𝗰𝗼𝗺𝗽𝗮𝗿𝗲𝗱 𝘁𝗼 𝗼𝘁𝗵𝗲𝗿 𝗶𝗻𝗱𝘂𝘀𝘁𝗿𝗶𝗲𝘀
Bank’s assets and liabilities are financial and hence easier to value than physical / intangible assets. This makes P/B more reliable for banks, as it aligns closely with their intrinsic value.

𝗯. 𝗥𝗲𝗴𝘂𝗹𝗮𝘁𝗼𝗿𝘀 𝗮𝗻𝗱 𝗶𝗻𝘃𝗲𝘀𝘁𝗼𝗿𝘀 𝗳𝗼𝗰𝘂𝘀 𝗼𝗻 𝗯𝗼𝗼𝗸 𝘃𝗮𝗹𝘂𝗲 𝗼𝗿 𝗰𝗮𝗽𝗶𝘁𝗮𝗹
Central Bank requires Banks to maintain a capital adequacy ratio i.e., banks are required to set aside capital (or equity or book value of equity) to give out loans. For simplicity’s sake, if CAR is 15% then banks need to set aside 15 as capital to give out a loan of 100.
Regulators need to ensure that a bank is always capitalized adequately. Investors focus on growth, which can only happen with capital adequacy.
P/B reflects how the market perceives a bank’s book value (or capital strength)

𝗰. 𝗣/𝗘 𝗳𝗹𝘂𝗰𝘁𝘂𝗮𝘁𝗲𝘀 𝘄𝗶𝘁𝗵 𝗽𝗼𝗶𝗻𝘁 𝗶𝗻 𝘁𝗶𝗺𝗲 𝗲𝗮𝗿𝗻𝗶𝗻𝗴𝘀
For banks, net profits or earnings are heavily dependent on the interest rate, credit cycles, bad loan provisioning etc. – this leads to P/E being a less reliable metric for banks.
e.g., Banks that provision more for bad loans (than the risky banks that typically provision less) report lower earnings and hence optically appear to have a higher P/E.

Moreover, P/E does not account history.
It takes earnings from a point in time. The good thing with P/B multiple is that BV contains earnings (retained earnings i.e., profit and loss) from past years and hence in a way has history and is without the P/E fluctuation.

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Watch the 1st two videos of this playlist if you are interested in learning how to analyze a Bank / FI
https://lnkd.in/eWF5wNfW

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