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

This text discusses the valuation of banks, emphasizing the importance of equity valuation and the impact of the 2008 financial crisis on investor perceptions. It argues that traditional valuation methods are inadequate for banks and proposes a bank-specific free cash flow to equity (FCFE) model. This model considers factors like regulatory capital, riskiness of investments, and the potential for bank runs. The author uses Citibank as a case study, highlighting its undervaluation despite low growth and profitability. The text then delves into the significance of price-to-book ratios in bank valuation, linking it to investor expectations of return on equity relative to the cost of equity. It observes a long-term decline in price-to-book ratios for US banks since 2008, suggesting increased risk perception despite improved capitalization. The author explores potential reasons for this decline, including heightened risk aversion, regulatory changes, and the rise of fintech competition. Finally, it acknowledges the views of value investors who see opportunity in undervalued banks but advises caution. The author concludes by emphasizing the need to understand both intrinsic value and market pricing dynamics to navigate bank investments successfully.