Now, while buying stocks at a fair price will tend to pay off over the long term, we all love to bag a real bargain.
If I had to use just one financial metric for valuing banks, it would be price-to-tangible net asset value (P/TNAV). If you can buy 1 of assets for less than a quid, youre on to a good thing provided, of course, that the assets are accurately valued and can provide a productive return.
It seems almost bizarre now that when I was highlighting the value in Lloyds for Motley Fool readers back in December 2011 the share price was 23.6p against a TNAV of 58.3p a P/TNAV of 0.4. Put another way, the market was offering investors the opportunity to pay just 40p for every 1 of Lloyds assets.
Sure, we all knew there were further asset writedowns to come, but 60p in the pound of worthlesness seemed way too pessimistic to me!
The situation today is very different. Lloyds share price is 75p against a TNAV of 50.7p a P/TNAV of 1.48. In other words, the market is now asking investors to pay 1.48 for every 1 of the banks assets.
At what price a bargain?
I dont expect to see Lloyds trading at a P/TNAV of 0.4 again in my lifetime. That was an exceptional rating during an exceptional period for financial markets.
Assuming we are now moving into more temperate economic climes, what valuation would put Lloyds in the bargain basement for me today?
Well, on a P/TNAV basis, Lloyds at 1.48 is easily the most expensive of the Footsies Big Five banks, with the next most richly-rated being Standard Chartered (1.23), followed by HSBC (1.11), Royal Bank of Scotland (0.93) and Barclays (0.80).
However, Im going to use as my benchmark Warren Buffets favourite bank and largest holding Wells Fargo. Like Lloyds, the US bank is a traditional lender with a sizeable share of its home mortgage market.
In the years before the financial crisis, Wells Fargo was delivering a super-efficient return on assets for a bank of about 1.7%, and was able to make a very decent return on equity with relatively modest financial leverage (a low assets/equity multiple). For this, the market was happy to pay a P/TNAV of around 3.
Post-financial crisis, Wells Fargos return on assets is heading back towards 1.7%; its currently up to over 1.4%. Meanwhile, the current P/TNAV is 2.22 a good discount to the historical 3.
Now, Lloyds return on assets in the years before the financial crisis was 0.85% half that of Wells Fargo. So, I reckon a rating of half the current P/TNAV of the US bank would put the Black Horse in tasty territory. As things stand, that translates into a P/TNAV of 1.11 for Lloyds, and a share price of just over 56p.
So, there you have my — simplistic — take on Lloyds. However, if you’re thinking about investing in banks, or already own shares, I would strongly urge you to expand your knowledge by reading the Motley Fool’s “Essential Guide to Investing in Banks“.
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G A Chester has no position in any shares mentioned. The Motley Fool UK owns shares in Standard Chartered. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.