IDEAS home Printed from https://ideas.repec.org/a/eee/glofin/v44y2020ics1044028317304787.html
   My bibliography  Save this article

Does relative valuation work for banks?

Author

Listed:
  • Forte, Gianfranco
  • Gianfrate, Gianfranco
  • Rossi, Emanuele

Abstract

We study the distribution and properties of valuation errors yielded by banking industry multiples for European and U.S. banks. The results highlight that stock-market multiples are best suited for U.S. institutions, and that a two-year-forward P/E is the most precise metric. Contrary to practitioner beliefs, P/tangible book value is less meaningful than P/BV. Multiples are less accurate for small commercial banks than for large ones, and for investment banks than for retail banks. We investigate whether large positive errors lead to one-year positive price performances and negative errors to negative price changes, and find that the forward P/E loses its predictive ability in comparison with historical multiples. Testing three investment strategies, we find that bank multiples can be profitably used in portfolio choices.

Suggested Citation

  • Forte, Gianfranco & Gianfrate, Gianfranco & Rossi, Emanuele, 2020. "Does relative valuation work for banks?," Global Finance Journal, Elsevier, vol. 44(C).
    • Handle: RePEc:eee:glofin:v:44:y:2020:i:c:s1044028317304787
    DOI: 10.1016/j.gfj.2018.09.002
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1044028317304787
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.gfj.2018.09.002?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Flannery, Mark J. & Kwan, Simon H. & Nimalendran, M., 2004. "Market evidence on the opaqueness of banking firms' assets," Journal of Financial Economics, Elsevier, vol. 71(3), pages 419-460, March.
    2. Asquith, Paul & Mikhail, Michael B. & Au, Andrea S., 2005. "Information content of equity analyst reports," Journal of Financial Economics, Elsevier, vol. 75(2), pages 245-282, February.
    3. Sanjeev Bhojraj & Charles M. C. Lee, 2002. "Who Is My Peer? A Valuation‐Based Approach to the Selection of Comparable Firms," Journal of Accounting Research, Wiley Blackwell, vol. 40(2), pages 407-439, May.
    4. Fama, Eugene F. & French, Kenneth R., 2012. "Size, value, and momentum in international stock returns," Journal of Financial Economics, Elsevier, vol. 105(3), pages 457-472.
    5. Bhattacharya, Nilabhra & Black, Ervin L. & Christensen, Theodore E. & Larson, Chad R., 2003. "Assessing the relative informativeness and permanence of pro forma earnings and GAAP operating earnings," Journal of Accounting and Economics, Elsevier, vol. 36(1-3), pages 285-319, December.
    6. Fama, Eugene F, 1991. "Efficient Capital Markets: II," Journal of Finance, American Finance Association, vol. 46(5), pages 1575-1617, December.
    7. R. David Mclean & Jeffrey Pontiff, 2016. "Does Academic Research Destroy Stock Return Predictability?," Journal of Finance, American Finance Association, vol. 71(1), pages 5-32, February.
    8. Alford, Aw, 1992. "The Effect Of The Set Of Comparable Firms On The Accuracy Of The Price Earnings Valuation Method," Journal of Accounting Research, Wiley Blackwell, vol. 30(1), pages 94-108.
    9. Beltratti, Andrea & Stulz, René M., 2012. "The credit crisis around the globe: Why did some banks perform better?," Journal of Financial Economics, Elsevier, vol. 105(1), pages 1-17.
    10. Park, Young S. & Lee, Jung-Jin, 2003. "An empirical study on the relevance of applying relative valuation models to investment strategies in the Japanese stock market," Japan and the World Economy, Elsevier, vol. 15(3), pages 331-339, August.
    11. Abarbanell, JS & Bushee, BJ, 1997. "Fundamental analysis, future earnings, and stock prices," Journal of Accounting Research, Wiley Blackwell, vol. 35(1), pages 1-24.
    12. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    13. Huizinga, Harry & Laeven, Luc, 2012. "Bank valuation and accounting discretion during a financial crisis," Journal of Financial Economics, Elsevier, vol. 106(3), pages 614-634.
    14. Kothari, S. P., 2001. "Capital markets research in accounting," Journal of Accounting and Economics, Elsevier, vol. 31(1-3), pages 105-231, September.
    15. Blau, Benjamin M. & Brough, Tyler J. & Griffith, Todd G., 2017. "Bank opacity and the efficiency of stock prices," Journal of Banking & Finance, Elsevier, vol. 76(C), pages 32-47.
    16. Cheng, C S Agnes & McNamara, Ray, 2000. "The Valuation Accuracy of the Price-Earnings and Price-Book Benchmark Valuation Methods," Review of Quantitative Finance and Accounting, Springer, vol. 15(4), pages 349-370, December.
    17. Ramnath, Sundaresh & Rock, Steve & Shane, Philip, 2008. "The financial analyst forecasting literature: A taxonomy with suggestions for further research," International Journal of Forecasting, Elsevier, vol. 24(1), pages 34-75.
    18. Bandyopadhyay, Sati P. & Brown, Lawrence D. & Richardson, Gordon D., 1995. "Analysts' use of earnings forecasts in predicting stock returns: Forecast horizon effects," International Journal of Forecasting, Elsevier, vol. 11(3), pages 429-445, September.
    19. Volker Herrmann & Frank Richter, 2003. "Pricing With Performance-Controlled Multiples," Schmalenbach Business Review (sbr), LMU Munich School of Management, vol. 55(3), pages 194-219, July.
    20. Jones, Jeffrey S. & Lee, Wayne Y. & Yeager, Timothy J., 2012. "Opaque banks, price discovery, and financial instability," Journal of Financial Intermediation, Elsevier, vol. 21(3), pages 383-408.
    21. Emanuele Rossi & Gianfranco Forte, 2016. "Assessing Relative Valuation in Equity Markets," Palgrave Macmillan Books, Palgrave Macmillan, number 978-1-137-56335-4.
    22. Sanjeev Bhojraj & Charles M. C. Lee & Derek K. Oler, 2003. "What's My Line? A Comparison of Industry Classification Schemes for Capital Market Research," Journal of Accounting Research, Wiley Blackwell, vol. 41(5), pages 745-774, December.
    23. Jing Liu & Doron Nissim & Jacob Thomas, 2002. "Equity Valuation Using Multiples," Journal of Accounting Research, Wiley Blackwell, vol. 40(1), pages 135-172, March.
    24. Bongini, Paola & Nieri, Laura & Pelagatti, Matteo, 2015. "The importance of being systemically important financial institutions," Journal of Banking & Finance, Elsevier, vol. 50(C), pages 562-574.
    25. Donald P. Morgan, 2002. "Rating Banks: Risk and Uncertainty in an Opaque Industry," American Economic Review, American Economic Association, vol. 92(4), pages 874-888, September.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Bartram, Söhnke M. & Grinblatt, Mark, 2018. "Agnostic fundamental analysis works," Journal of Financial Economics, Elsevier, vol. 128(1), pages 125-147.
    2. WS Nel, 2015. "An Optimal Peer Group Selection Strategy for Multiples-Based Modelling in the South African Equity Market," Journal of Economics and Behavioral Studies, AMH International, vol. 7(3), pages 30-46.
    3. Christian Weiner, 2005. "The Impact of Industry Classification Schemes on Financial Research," SFB 649 Discussion Papers SFB649DP2005-062, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    4. Karel Janda, 2019. "Earnings Stability and Peer Company Selection for Multiple Based Indirect Valuation," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 69(1), pages 37-75, February.
    5. Fosu, Samuel & Danso, Albert & Agyei-Boapeah, Henry & Ntim, Collins G. & Murinde, Victor, 2018. "How does banking market power affect bank opacity? Evidence from analysts' forecasts," International Review of Financial Analysis, Elsevier, vol. 60(C), pages 38-52.
    6. Frank Asche & Bård Misund, 2016. "Who’s a major? A novel approach to peer group selection: Empirical evidence from oil and gas companies," Cogent Economics & Finance, Taylor & Francis Journals, vol. 4(1), pages 1264538-126, December.
    7. Ramnath, Sundaresh & Rock, Steve & Shane, Philip, 2008. "The financial analyst forecasting literature: A taxonomy with suggestions for further research," International Journal of Forecasting, Elsevier, vol. 24(1), pages 34-75.
    8. Ahmed Baig & Benjamin M. Blau & Todd G. Griffith, 2021. "Firm Opacity and the Clustering of Stock Prices: the Case of Financial Intermediaries," Journal of Financial Services Research, Springer;Western Finance Association, vol. 60(2), pages 187-206, December.
    9. José Couto & Paula Brito & António Cerqueira, 2017. "The Method of Market Multiples on the Valuation of Companies: A Multivariate Approach," FEP Working Papers 586, Universidade do Porto, Faculdade de Economia do Porto.
    10. Benoît D'Udekem, 2014. "Bank Cash Holdings and Investor Uncertainty," Working Papers CEB 14-002, ULB -- Universite Libre de Bruxelles.
    11. Emanuel Bagna & Enrico Cotta Ramusino, 2016. "Accounting-Based Valuation Using Market Multiples: The Case Of Cyclical Companies," DEM Working Papers Series 126, University of Pavia, Department of Economics and Management.
    12. Yanfu Li, 2019. "Improving Analyst Target Price Performance Through Enhanced Valuation Techniques," Global Journal of Business Research, The Institute for Business and Finance Research, vol. 13(2), pages 1-12.
    13. Ingolf Dittmann & Christian Weiner, 2005. "Selecting Comparables for the Valuation of European Firms," SFB 649 Discussion Papers SFB649DP2005-002, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    14. Lucie Courteau & Jennifer L. Kao & Terry O’Keefe & Gordon D. Richardson, 2006. "Relative accuracy and predictive ability of direct valuation methods, price to aggregate earnings method and a hybrid approach," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 46(4), pages 553-575, December.
    15. Lu Zhang, 2017. "The Investment CAPM," European Financial Management, European Financial Management Association, vol. 23(4), pages 545-603, September.
    16. Benjamin R. Auer, 2019. "Does the strength of capital market anomalies exhibit seasonal patterns?," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 43(1), pages 91-103, January.
    17. Marc Deloof & Wouter De Maeseneire & Koen Inghelbrecht, 2009. "How Do Investment Banks Value Initial Public Offerings (IPOs)?," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 36(1‐2), pages 130-160, January.
    18. Meitner, Matthias, 2003. "Option-Style Multi-Factor Comparable Company Valuation for Practical Use," ZEW Discussion Papers 03-76, ZEW - Leibniz Centre for European Economic Research.
    19. Flood, Mark D. & Kenett, Dror Y. & Lumsdaine, Robin L. & Simon, Jonathan K., 2020. "The Complexity of Bank Holding Companies: A Topological Approach," Journal of Banking & Finance, Elsevier, vol. 118(C).
    20. WS Nel & NJ le Roux, 2014. "Precision, Consistency and Bias in Emerging Equity Markets," Journal of Economics and Behavioral Studies, AMH International, vol. 6(5), pages 386-399.

    More about this item

    Keywords

    Banks; Relative valuation; Banking multiples; Equity valuation; Valuation errors;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:glofin:v:44:y:2020:i:c:s1044028317304787. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/620162 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.