The price-to-earnings (P/E) and price-to-book (P/B) ratios can help you compare banks in terms of their growth potential and risk profile. The efficiency ratio quantifies a bank's utilization of its assets, while the loan-to-deposit ratio (LDR) is an important liquidity measure.
A common multiple used by bank analysts is the Price-Earnings ratio (P/E). One proceeds in three steps. In the first step, one searches for comparable, similar banks listed on the stock market, and one computes for each the ratio of the stock price to the earnings-per-share. This is the P/E ratio.
Valuation Multiples – Banks and Insurance
The two key valuation multiples for both banks and insurance firms are P / E (Price Per Share / Earnings Per Share) and P / BV (Price Per Share / Book Value Per Share).
Enterprise value multiples are better than equity value multiples because the former allow for direct comparison of different firms, regardless of capital structure. Recall, that the value of a firm is theoretically independent of capital structure. Equity value multiples, on the other hand, are influenced by leverage.
The most common multiple used in the valuation of stocks is the P/E multiple. It is used to compare a company's market value (price) with its earnings. A company with a price or market value that is high compared to its level of earnings has a high P/E multiple.
Market conditions or changes within the company can cause a company's earnings to grow or contract over time. This can make historical EBITDA a poor proxy for future operating cash flow. EBITDA multiples also don't consider future working capital needs or trends that may affect future cash flow.
The most sufficient multiples for bank valuation are the price-earning ratio (P/E) and the price-to-book value ratio (P/BV).
Common ratios used are the net interest margin, the loan-to-assets ratio, and the return-on-assets (ROA) ratio. Net interest margin is used to analyze a bank's net profit on interest-earning assets like loans, while the return-on-assets ratio shows the per-dollar profit a bank earns on its assets.
The P/E multiple paid for strong earning sellers is almost always lower than the national median and average multiple because these high performing banks have already done the heavy lifting by keeping costs low, and it is reflected in their standalone earnings.
These multiples are: EV/EBITDA – Due to the fact that both EV (Enterprise Value) and EBITDA (Earnings before interest, taxes, depreciation, and amortization) accommodate for debts, investors and financial experts employ this multiple. The ideal EV/EBITDA range is 6 to 15 times.
Banking. AAA Rating. AAA*, or Triple-A, is the highest rating assigned by credit rating agencies to companies and their financial obligations. Moody's has a slight variation from the other agencies, where they use 'Aaa' as the designation for their highest rating.
The most commonly used method to value banks is price-to-earnings (P/E), measured as the ratio of the bank's stock price to its earnings per share (EPS). It helps assess the bank's market value relative to earnings.
One of the most important KPIs for banks, net interest margin (NIM) reveals a bank's net profit on interest-earning assets, such as loans or investment securities. Since the interest earned on these assets serves as a primary source of revenue for a bank, this metric can indicate a bank's overall profitability.
CASA ratio of a bank is the ratio of deposits in current, and saving accounts to total deposits. A higher CASA ratio indicates a lower cost of funds, because banks do not usually give any interests on current account deposits and the interest on saving accounts is usually very low 3–4%.
In the banking industry, typically, the market price-to-book (P/B) ratio is considered the valuation multiple because of how closely a bank's value is tied to its balance sheet.
What are good ratios for a company? Generally, the most often used valuation ratios are P/E, P/CF, P/S, EV/ EBITDA, and P/B. A “good” ratio from an investor's standpoint is usually one that is lower as it generally implies it is cheaper.
A measure of equity cash usage, free cash flow to equity (FCFE) calculates how much cash is available to the equity shareholders of a company after all expenses, reinvestment, and debt are paid. Free cash flow to equity is composed of net income, capital expenditures, working capital, and debt.
The following are some common valuation multiples for small businesses: Retail: 0.5 – 1.5 times EBITDA. Restaurants: 0.5 – 2.0 times EBITDA. Manufacturing: 0.5 – 3.0 times EBITDA.
Industry Use: EV/EBITDA is often preferred for industries where companies carry significant debt, such as utilities or telecoms, as it provides a clearer view of operational performance. The P/E ratio is more common in industries where companies rely less on debt or are primarily equity-financed.
We do not use a DCF if the company has unstable or unpredictable cash flows (tech or bio-tech start-up) or when debt and working capital serve a fundamentally different role.
The Rule of 40 states that the sum of a healthy SaaS company's annual recurring revenue growth rate and its EBITDA margin should be equal to or exceed 40%. It is a measure of how well a SaaS balances growth with profitability.
When it comes to analyzing the performance of a company on its own merits, some analysts see free cash flow as a better metric than EBITDA.
For most businesses with EBITDA of $1,000,000 - $10,000,000, the EBITDA multiple will be in the general range of 4.0x to 6.5x, increasing as EBITDA increases.