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U.S. banks are cheap and operate in a market that's largely recovered from its real estate bust. (David Paul Morris/Bloomberg)
U.S. banks are cheap and operate in a market that's largely recovered from its real estate bust. (David Paul Morris/Bloomberg)

Strategy Lab

Big U.S. banks on 3-for-1 sale: Buy now Add to ...

Norman Rothery is the value investor for Globe Investor’s Strategy Lab. Follow his contributions here and view his model portfolio here.

Two-for-one sales can inspire mixed feelings in the aisles of the grocery store. While I love big discounts, I have a hard time accommodating an extra bag of potato chips. But I never get my fill of bargain stocks and the market is now offering a rare three-for-one deal on U.S. bank stocks.

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Heading south to buy banks doesn’t come easily to many Canadians who love their hometown heroes and their many attractive qualities. The big Canadian banks are seen as safe bets and have a long history of paying generous tax-advantaged dividends. The industry also operates as a cozy oligopoly that has a great deal of pricing power, which has only gotten better due to the recent acquisitions of Ally and ING Direct.

However, the real estate collapse that pummelled the United States is long overdue to make an appearance north of the border. As it stands, housing remains unaffordable in many large Canadian cities and that prompts many new homeowners to take on debt that can only be repaid under optimistic scenarios. An unexpected breeze could knock real estate prices down and a collapse is possible – which wouldn’t do our banks, or the economy, any good.

On the other hand, U.S. banks are much less than loved and operate in a more competitive environment. The real estate market stateside has already corrected and it’s likely to improve over time, which should help to buoy U.S. banks.

Real estate aside, my main beef with Canadian bank stocks is simply their price. They trade at valuations that are far higher than their U.S. counterparts.

To get a sense of bank valuations I like to start with tangible book value which tallies up a firm’s assets, excluding intangible items like goodwill, and subtracts liabilities. While it’s not a perfect gauge, banks with modest price-to-tangible-book-value ratios (P/TB) are often bargains.

As a rough rule of thumb, bad times tend to push bank stocks to, or below, tangible book value, where they often represent good deals. On the other hand, banks may trade at two, three, or even more times tangible book value in happy times, when it might be better to sell them.

These days the big Canadian banks trade between about 1.8 and 3.1 times tangible book value, which is reasonably high, historically speaking. The cheapest of the bunch is the Bank of Montreal. As it often does, Royal Bank of Canada takes the crown at the high end.

On the other hand, it’s easy to find large U.S. banks trading at, or below, tangible book value, which makes them much cheaper than Canadian banks.

The accompanying table shows a selection of large U.S. and Canadian banks and how they stack up based on their P/TB ratios. For instance, you could swap Royal Bank for Bank of America and buy 3.7 times as much tangible book value in the process. It’s even better than a three-for-one sale.

Mind you, the difference in ratios was not always so wide. At one point U.S. banks were the darlings of the industry and traded at higher ratios than the Canadian banks, which were then viewed as being far too stodgy.

Back in 2006 both Bank of America and RBC traded at more than four times tangible book value.

Times have changed and the economic trajectory of the two countries has, to some extent, worn off on the stocks. But the valuation difference will likely narrow over time as it has many times before. As a result, you might want to pick up a few of those three-for-one bargains while the getting is good.

 

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How The Banks Stack Up

Company Ticker Recent
Price $
P/TB P/E Yield (%)
U.S.
Citigroup C-N 42.16 0.81 16.6 0.1
Bank of America BAC-N 11.3 0.85 44.5 0.36
KeyCorp KEY-N 9.38 0.97 10.5 2.16
Comerica CMA-N 33.86 1.01 12.6 2.03
SunTrust Banks STI-N 27.72 1.06 7.64 0.73
Regions Financial RF-N 7.62 1.08 9.87 0.53
Zions Bancorp. ZION-Q 24.11 1.17 23.5 0.17
Huntington Bancshares HBAN-Q 7.03 1.19 9.58 2.35
First Horizon National FHN-N 10.52 1.22 NM 1.94
JPMorgan Chase JPM-N 49.28 1.25 9.15 2.52
Fifth Third Bancorp FITB-Q 15.72 1.26 9.37 2.57
PNC Financial Services PNC-N 61.68 1.32 11.5 2.62
Wells Fargo WFC-N 35.13 1.52 10.3 2.88
BB&T Corporation BBT-N 30.39 1.82 11.1 3.06
M&T Bank MTB-N 102.65 2.3 13.5 2.74
U.S. Bancorp USB-N 34.03 2.62 11.9 2.31
Canada
Bank of Montreal BMO-T 63.77 1.8 10.5 4.52
TD Bank TD-T 84.29 2.6 12.4 3.66
CIBC CM-T 83.88 2.64 10.6 4.5
Bank of Nova Scotia BNS-T 60.6 2.7 11.6 3.77
National Bank of Canada NA-T 78.19 2.72 8.36 4.26
Royal Bank of Canada RY-T 63.48 3.12 12.7 3.79

Source: S&P Capital IQ

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  • BMO-T
  • TD-T
  • CM-T
  • BNS-T
  • NA-T
  • RY-T
  • C-N
  • BAC-N
  • KEY-N
  • CMA-N
  • STI-N
  • RF-N
  • ZION-Q
  • HBAN-Q
  • FHN-N
  • JPM-N
  • FITB-Q
  • PNC-N
  • WFC-N
  • BBT-N
  • MTB-N
  • USB-N
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