Top Performing Banks Get Short Shrift; Stock Market Rewards Stars of Other Industries More
Gregor, William T., Frieder, Larry A., American Banker
A quick glance at the American Banker bank index on page 23 might make anyone think 1995 was a stellar year for banks in the stock market. Almost every month, the index outpaced the Standard & Poor's 500.
But take a closer look. Even the better-managed banks still don't receive the premium multiples investors pay for the leading companies in other industries that face similar problems.
In fact, a major Gemini Consulting survey shows market premiums for top performing banks are barely half those of top firms in industries facing comparable challenges.
It's a stock market axiom that in any industry, no matter what its prospects, the top-performing companies typically trade at a premium to their lesser competitors. Yet this study indicates high performance by bank managements counts in investors' minds far less than the achievements of high-performing companies in other industries.
To gauge operating performance among banks, the study identified the critical success factors we believe separate bank managements.
Invariably, the better banks hew to strategies that foster value creating cultures. These are the banks that eagerly embrace change, focus their strategic business mix, and constructively participate in deal making and acquisitions that embrace both of the above.
With an understanding of customer behavior and market potential, they stand out by marketing superior products, fostering customer relationships, building efficient delivery systems, and relentlessly controlling costs.
Based on these criteria, our list of top bank performers averaged a 12.5 price-to-earnings ratio and a trading premium of 2.0 times book value in the second quarter of 1995. In contrast, their lesser competitors, on average, had an 11.1 ratio and traded at 1.6 times book. So much for investors rewarding superior managements.
To put this discrimination in perspective, we surveyed 88 other industries facing issues similar to those confronting banks - slow growth, market saturation, high fixed costs, big expenditures for technology, and shrinking margins.
We focused on industries that also were strongly influenced by regulation and to some extent by interest rate cycles. The half- dozen that came closest were textiles, food wholesalers, health insurance, home building, retail stores, and securities.
For these industries, the average price-to-earnings ratio based upon 1995 second-quarter figures was 13.3, but that of the top performers was 19.3. Similarly, the average market-to-book value for the selected companies in the six industries was 1.8 versus 4.0 for top performers, a far greater premium than investors accorded to the top performers in the banking industry.
Bluntly put, investors don't differentiate between banks as they do between leaders and the also-rans in other industries facing similar challenges.
The discrepancy is significant. Typically, the better banks not only match the earnings growth of the leaders in the other industries, but generate higher returns and lower risk. In effect, investors are taking a double swipe against banks by lowering multiples and lowering relative premiums.
This is not a recent market phenomenon. We conducted similar tests using data going back to 1990 and found a consistent pattern over time.
Arguably, banks are inconsistent stock market performers, and this may have biased investors against bidding up their stock valuations. According to an American Banker survey of market-to- book valuations, only three of the top 10 performers among the superregionals in 1986 made the list in 1994. …