I was not sure what to write this week as some analysis of companies are waiting for further results. Among other things, an analysis of Research In Motion expects the publication of results on Wednesday. So I've write an article I did for my investment club in the U.S. banking system. This article was written 20 days ago. I'll write some red patches or updates to data.
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Canada-US Differences
System banking market is very tight and highly regulated. The six largest Canadian banks (known as the Big6 which includes the Royal Bank, Bank of Montreal, Scotiabank, CIBC, TD and National Bank) account for over 90% of the local financial market. Considering that Desjardins holds 5% market share in Canada, the 60 other financial institutions in Canada share the little remaining 5%.
Partly this explains the strict regulation of the financial system in Canada. If one institution has the Big6 to fail, the entire Canadian economy who might fall.
the U.S. side, the situation is very different. There are over 8,000 U.S. banks and most banks are only present in a local five-state American. The four largest U.S. banks (Bank of America, Citigroup, JP Morgan and Wells Fargo) now own 40% of the U.S. banking market after numerous acquisitions of banks in default. For example, Wells Fargo has increased from 4% to 10% after its acquisition of Wachovia.
Even if the 4 largest U.S. banks may weaken the economy in the event of a bankruptcy, the situation is less critical than in Canada. It is between each other which explains the presence of reduced regulation. Note however that the crisis of recent years is partly due to the lack of rules in the United States (and the situation is about to be revisited with new rules that require the administration wants Obama) .
How to evaluate a bank
evaluate a financial institution is really different from other companies. This stems from the fact that other deposits that are considered a debt to the bank. A bank therefore has a very high debt. Here, I'll just quickly explain the 2 methods used by U.S. analysts: The book value and earnings power.
Depending on how the book value, we take the tangible book value of the shares of the company and is multiplied by 1.75 (according to the historical value). For a company in trouble (like Citigroup) analysts instead use a multiple of 1 to 1.20.
For method of power benefits, it is forecasting earnings per share in the next fiscal year (in our case 2011) and is multiplied by 10 (historical). Here
values that gives for the 4 largest U.S. banks.
Note that the "Price Current" is dated March 8. Today, their prices are respectively 4.31 to 17.90 - 45.02 to 31.22.
We see from the chart that the evaluation by book value suggests a large underestimation of Citigroup. However, for profits, this underestimation seems less important.
The best business bank in the U.S. is, in my view, Wells Fargo. However, the two methods of assessment, it is both very expensive at this time. I see evidence here that this is one of the banks the strongest in the American system: people are willing to pay a premium.
What to do?
To run this little test on other major banks, I believe the U.S. bank is generally good price (depending on consensus). Take a position on an ETF would be advantageous only if one thinks that analysts underestimate the future earnings.
I do not see the point to take a position in Wells Fargo (too expensive). If you want to expose the U.S. financial system, it must be out of the bank (and go into the brokerage, banking or insurance) or play on Citigroup. (Those who looked at the composition of my portfolio saw options on Citigroup. I took this position because I believe that U.S. analysts have underestimated the ability of the bank to get out of the crisis. However, this is a risky and for this reason that my position is small.)
Citigroup is the only title the conclusion of book value and income are not similar. Taking the 1.75 X as its industry peers, we should have a price of $ 7.27 while earnings show $ 3.80 instead. In the long term, the two will converge either to an increase in profits (in the event of a successful reorganization of the company) either by a decline in book value (the company has failed and destroyed shareholder value). But I think the risk here would be too big for the club.
The logical conclusion is to look elsewhere than in the U.S. banking.
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