Financial Sector Value US Stocks — Cheap Banks and Financials by P/B and ROE

Bank assets (loans, securities, derivatives) are primarily financial instruments whose book values approximate economic values better than industrial company fixed assets. For banks, book value is the most reliable proxy for net economic worth. P/B below 1 means the market values the bank at a discount to its reported net assets — meaningful only because bank assets are more reliably valued than most industrial company assets.

Bank ROE = Net Income / Shareholders' Equity. For US banks, the cost of equity is typically 8-11% depending on risk profile. ROE consistently above 10% means the bank generates returns above its cost of equity — justifying above-book valuation. ROE below 8% means the bank earns less than it costs equity investors to hold it — rationally deserving below-book valuation. The 10% threshold in this screen captures banks at or above break-even quality.

NIM (Net Interest Margin) = (Interest Income − Interest Expense) / Interest-Earning Assets. It's the spread between what a bank earns on loans and what it pays on deposits. NIM is the primary driver of bank profitability. Rising rates typically expand NIM (banks can raise loan rates faster than deposit rates). Falling rates compress NIM. NIM trend is the single most important earnings driver for most commercial banks.

CET1 (Common Equity Tier 1) ratio = Core Capital / Risk-Weighted Assets. Regulators require banks to maintain minimum CET1 ratios (typically 4.5-6% minimum, 7-8% well-capitalized standard, 10%+ strongly capitalized). Higher CET1 means more buffer against credit losses before insolvency. Banks with CET1 above 12% can weather significant stress while maintaining dividends. The capital ratio is the financial sector equivalent of D/E — it measures solvency resilience.

Several US regional banks (Silicon Valley Bank, Signature Bank, First Republic) failed or were seized in 2023 due to: (1) Interest rate risk mismanagement — holding long-duration fixed-rate securities funded by short-term deposits when rates rose sharply, creating large unrealized losses. (2) Concentrated deposit bases of uninsured institutional depositors who could withdraw rapidly. (3) Insufficient capital buffers. The crisis highlighted that bank quality analysis must include duration risk and deposit stability.

Insurance companies are also valued on P/B, but book value is affected by investment portfolio mark-to-market changes and actuarial assumptions. Key metrics differ: combined ratio (total claims + expenses / premiums) measures underwriting profitability; investment income from the float measures investment return. The float (premium payments held before claims) is insurance's equivalent of bank deposits. P/B combined with combined ratio below 100% is the insurance equivalent of the bank P/B and ROE screen.

The standard D/E threshold of below 1 used for industrial companies is inappropriate for banks and insurance. Banks structurally fund their assets with deposits and borrowed money — a D/E of 8-12× is normal for banks. This screen uses D/E below 2, which in financial sector context captures the most conservatively leveraged end of the spectrum — banks and financials that maintain low leverage relative to their sector peers.

For banks: P/B = (ROE − g) / (COE − g), where g = sustainable growth rate and COE = cost of equity. If ROE = 12%, COE = 10%, g = 5%, then P/B = (12-5)/(10-5) = 1.4. This framework shows that a bank with ROE of 12% rationally trades at 1.4× book. P/B below 1.2 with ROE above 10% suggests the market is applying a more pessimistic COE or lower expected ROE than the historical trend implies.

REITs (Real Estate Investment Trusts) are in the Real Estate sector under GICS classification, not Financial Services. This screen targets banks, insurance companies, investment managers, and diversified financials within the formal financial sector classification. REITs use different valuation metrics (P/FFO or Price/NAV) and have different financial characteristics. The Highest Dividend Yield screen captures REIT income opportunities.

Key credit quality metrics from the bank's financial statements: (1) Non-performing loans as % of total loans (below 1% is excellent, above 3% is concerning). (2) Net charge-off rate (actual loan losses as % of loans — above 1% is elevated). (3) Allowance for loan losses / Non-performing loans (coverage ratio — above 100% means the loss reserve exceeds current bad loans). (4) Loan growth rate relative to deposit growth — rapid loan growth without matching deposits is a risk indicator.