{"id":20845,"date":"2019-10-02T18:52:59","date_gmt":"2019-10-02T23:52:59","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/biws\/?post_type=biws_kb&#038;p=20845"},"modified":"2024-08-01T19:19:27","modified_gmt":"2024-08-02T00:19:27","slug":"price-to-book-value","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/bank-modeling\/price-to-book-value\/","title":{"rendered":"Price to Book Value Ratio &#8211; Interpretation and Derivation (23:02)"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_81 counter-flat ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Price to Book Value Ratio - Interpretation and Derivation<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/breakingintowallstreet.com\/kb\/bank-modeling\/price-to-book-value\/#Price_to_Book_Value_Ratio_%E2%80%93_Interpretation_and_Derivation\">Price to Book Value Ratio &#8211; Interpretation and Derivation<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/breakingintowallstreet.com\/kb\/bank-modeling\/price-to-book-value\/#What_Drives_Dividends\">What Drives Dividends?<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/breakingintowallstreet.com\/kb\/bank-modeling\/price-to-book-value\/#Real-Life_Uses_and_Interpretation\">Real-Life Uses and Interpretation<\/a><\/li><\/ul><\/nav><\/div>\n\n<h2><span class=\"ez-toc-section\" id=\"Price_to_Book_Value_Ratio_%E2%80%93_Interpretation_and_Derivation\"><\/span>Price to Book Value Ratio &#8211; Interpretation and Derivation<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<style>.enteremail__large--inline{margin:60px auto!important}<\/style>\n<p>Here\u2019s a question that came in the other day:<\/p>\n<p>\u201cI see that in the public comps of your Bank Valuation model, Citi is trading below a 1x P \/ TBV (Price to Tangible Book Value) multiple.<\/p>\n<p>Is the market saying that Citi\u2019s shares are worth less than the liquidation value of the company? How does that make sense?\u201d<\/p>\n<p>\u201cAlso, what does it mean if the bank were trading at a higher P \/ TBV or P \/ BV multiple, either over 1x or at a higher number than the comparables?\u201d<\/p>\n<p>The ANSWER is that P \/ BV (or P \/ TBV etc.) multiples represent *shorthand* for the valuation of commercial banks.<\/p>\n<div class='code-block code-block-3' style='margin: 8px 0; clear: both;'>\n<div class=\"kb-adinsert-modal\">\n    <div class=\"kb-adinsert-top\">\n      <div class=\"media\">\n          <img decoding=\"async\" class=\"alignnone size-full wp-image-28448\" src=\"https:\/\/mergersandinquisitions.com\/wp-content\/uploads\/2024\/04\/Bank-Financial-Institution-Modeling.png\" alt=\"Bank Modeling\" width=\"128\" height=\"128\" \/>\n      <\/div>\n      <div class=\"content\">\n          <h3>Master Bank and Financial Institution Valuation and Financial Modeling<\/h3>\n      <\/div>\n    <\/div>\n    \n    <div class=\"full_text\">\n    \t<ul>\n        \t<li>\n            \t<h4>Master financial institution modeling and valuation<\/h4>\n              <p>Build operating models, perform valuations, and analyze M&A deals with 4 global case studies<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Dominate interviews and excel on the job<\/h4>\n            <p>Create professional deliverables like stock pitches, equity research reports, and IB pitch books<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Explore private equity and growth equity scenarios<\/h4>\n            <p>Study buyouts and minority-stake deals in the financial services sector\n\n<\/p>\n\t\t\t  <\/li>\n      <\/ul>\n        \n      <a class=\"cta-link orange-button-medium\" href=\"https:\/\/breakingintowallstreet.com\/bank-modeling\/\" target=\"_blank\">Full Details<\/a>\n      \n      <a class=\"cta-link orange-button-medium bg-blue\" href=\"https:\/\/biws-support.s3.us-east-1.amazonaws.com\/Course-Outlines\/Bank-Modeling-Course-Outline.pdf\" target=\"_blank\" rel=\"noopener\">Short Outline<\/a>\n    <\/div>\n<\/div>\n<\/div>\n\n<p>They\u2019re all about *expected* returns vs. *targeted* returns:<\/p>\n<p>If P \/ BV is above 1x, it means the ROE of a bank exceeds its Cost of Equity.<\/p>\n<p>If P \/ BV equals 1x, it means that ROE equals Cost of Equity.<\/p>\n<p>If P \/ BV is below 1x, it means that ROE is below Cost of Equity.<\/p>\n<p>Multiples: Shorthand for a DCF or Dividend Discount Model Valuation<\/p>\n<p>In a DCF, if you know a company\u2019s Final Year FCF, Terminal FCF<br \/>\nGrowth Rate, and the Discount Rate (WACC), you can figure out its *implied* EBIT or EBITDA multiple.<\/p>\n<p>In other words, if you make those assumptions, the multiple tells you how much you\u2019d be willing to pay for the company to earn the return you\u2019re targeting.<\/p>\n<p>For commercial banks, those metrics are meaningless because interest income is a critical component of revenue and you can\u2019t separate operating and non-operating assets and liabilities.<\/p>\n<p>So instead, you rely on Dividends, Net Income Growth, and Cost of Equity for valuation, and they are all linked to the P \/ BV multiple.<\/p>\n<p>Specifically, the Terminal Equity Value for a commercial bank = Dividends One Year After the Final Year \/ (Discount Rate \u2013 Net Income Growth Rate)<\/p>\n<h2><span class=\"ez-toc-section\" id=\"What_Drives_Dividends\"><\/span>What Drives Dividends?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>The key factors influencing Dividends are the bank\u2019s Book Value, its <a href=\"https:\/\/breakingintowallstreet.com\/kb\/financial-statement-analysis\/return-on-equity-roe\/\" target=\"_blank\" rel=\"noopener\">Return on Equity (ROE)<\/a>, its Payout Ratio, and its Net Income Growth Rate\u2026 a bank generates Net Income from its Book Value and ROE, and then it issues a certain amount in the form of Dividends.<\/p>\n<p>And then it grows its Net Income at a certain rate in the next year.<\/p>\n<p>So you can rewrite this formula as:<\/p>\n<p>Implied Equity Value = BV * ROE * Payout Ratio * (1 + NI Growth Rate) \/ (Cost of Equity \u2013 NI Growth Rate)<\/p>\n<p>Since P \/ BV = Equity Value \/ Book Value, you can rewrite that as:<br \/>\nP \/ BV = ROE * Payout Ratio * (1 + NI Growth Rate) \/ (Cost of Equity \u2013 NI Growth Rate)<\/p>\n<p>Then, you can make ROE correspond to the bank\u2019s Net Income in the NEXT period instead, so it becomes:<\/p>\n<p>P \/ BV = Next Year ROE * Payout Ratio \/ (Cost of Equity \u2013 NI Growth Rate)<\/p>\n<p>Getting Rid of the Payout Ratio Term<\/p>\n<p>A bank has two options for its Net Income: it can pay it out in the form of Dividends, or hold onto it and actually get more Net Income for growth purposes.<\/p>\n<p>You can reflect this relationship as:<\/p>\n<p>Net Income Growth = (1 \u2013 Payout Ratio) * ROE<\/p>\n<p>NI Growth = ROE \u2013 ROE * Payout Ratio<\/p>\n<p>NI Growth \u2013 ROE = \u2013 ROE * Payout Ratio<\/p>\n<p>ROE \u2013 NI Growth = ROE * Payout Ratio<\/p>\n<p>And then you can plug in this term to the equation:<\/p>\n<p>P \/ BV = ROE * Payout Ratio \/ (Cost of Equity \u2013 NI Growth Rate)<\/p>\n<p>P \/ BV = (ROE \u2013 NI Growth Rate) \/ (Cost of Equity \u2013 NI Growth Rate)<\/p>\n<p>And this tells you the key relationship between all these terms.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Real-Life_Uses_and_Interpretation\"><\/span>Real-Life Uses and Interpretation<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>So are Citi\u2019s shares worth less than its liquidation value?<\/p>\n<p>Technically, yes\u2026 but it might be better to think of it as:<\/p>\n<p>\u201cThe market believes Citi\u2019s ROE will be less than its Cost of Equity, and therefore its Net Assets are worth less than their current Balance Sheet values.\u201d<\/p>\n<p>If a bank\u2019s ROE and P \/ BV are both high, that doesn\u2019t tell you much; same if they are both low.<\/p>\n<p>You find the interesting opportunities and (potentially) incorrectly valued banks when the ROE is low but the P \/ BV multiple is high, or when the ROE is high but the P \/ BV multiple is low.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>In this Price to Book Value Ratio &#8211; Interpretation and Derivation lesson, you\u2019ll learn about the relationship between Price to Book Value (P\/BV), Return on Equity (ROE), and Cost of Equity (Ke) for commercial banks, including how you can derive a formula for P\/BV that links these key variables, plus Net Income Growth, together. You\u2019ll also learn how you can use this information to determine if a bank might be overvalued or undervalued.<\/p>\n","protected":false},"featured_media":21896,"template":"","class_list":["post-20845","biws_kb","type-biws_kb","status-publish","has-post-thumbnail","hentry","kb_category-bank-modeling"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/20845","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media\/21896"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=20845"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}