Price-to-book: how banks and insurers are valued

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Key idea: For banks and insurers, the balance sheet is the business, so price-to-book and return on equity matter more than cash flow.

A bank's "debt" is mostly customer deposits, and its "inventory" is loans. Cash-flow methods built for factories and software firms do not fit, so analysts lean on book value: what the balance sheet says shareholders own.

Price-to-book (P/B) is share price divided by book value per share. A P/B of 1.0 means the market values the bank at exactly its accounting net worth.

Whether that is cheap depends on return on equity (ROE), which you will meet properly on Day 15. A bank earning 15% a year on its equity can deserve well over 1x book. One earning 6%, below what owners require, can deserve less than book, because every dollar it keeps earns too little.

Equity Rank leans on these balance-sheet methods for banks and insurers, which is why their fair values look different from an ordinary company's.

Quick check

A bank's share price is $30 and its book value per share is $25. What is its P/B?

Read: how the model values a bank →

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