For this Special Report we have chosen 60 banks from around the world. Each bank is systemically important in its home country. We have estimated the fair value of these banks' Price-to-Book (P/B) ratio.
According to our model, Commerzbank AG (in Germany) is the most undervalued bank in our sample. Its stock price should double within the next three years. Deutsche bank appears fairly valued. Mexican banks are the most overvalued.
Last time we ran our model was in May 2016. At the time we argued that HSBC stock was the best play on BrExit because it was significantly undervalued, had a high dividend yield, and was globally diversified. At the time, HSBC stock was trading at £4.30. Today it is trading at £5.60. Our model says that it is still somewhat undervalued.
Being long a basket of Canadian banks and short a basket of Australian banks is a good risk-reward trade.
Short Mexican banks vs long a combination of Santander and a few LatAm banks (see Chart 2) is a good risk-reward trade for two reasons. First, over- vs undervalued. Second, it is a good hedge against a Donald Trump presidency.
Long Sberbank vs short VTB (both in Russia) is also a good risk-reward trade.
Long a basket of Commerzbank, HSBC and DNB vs short a basket of Credit Suisse, Swedbank and Danske is another good trade. Our non-linear model has four independent variables and they explain more than 80% of the difference in valuations of these 60 banks. This is a "cross-sectional analysis”—that is, we value these banks vis-a-vis each other rather than each bank in isolation.
Just because a bank trades at a P/B ratio of 0.5 doesn't mean that it is a good investment. Our study shows that certain bank stocks that trade at a P/B ratio of 0.5 are still overvalued. Equally, just because a bank trades at a P/B ratio of 1.9 doesn't mean that said bank is expensive.
Because the duration of most banks' assets is not too long, the book value of banks is usually not far from the fair value of its assets.
Click here to access the report