One of the traditional valuation methodologies for bank stocks is the Price to Tangible Common Equity per share (P/TCE) multiple. While other factors such as proxies for risk and growth contribute, the principal variant that explains a bank’s P/TCE is its forward earnings expectations. Although, we at Cybiont Capital rely on multivariant models and our own earnings estimates for portfolio purposes, we actively monitor the evolution of the simplified single variable model for the insights it provides about the market’s perception of risk and its confidence in earnings consensus.

To do this we perform a daily regression of Price to 1-year Forward Tangible Common Equity per share versus Consensus Next 12 months Return on Tangible Common Equity (NTM ROTCE) for a universe of 232 publicly traded US Bank stocks.[1] Chart 1 illustrates the resultant regression for September 7. With an r squared of 54.7%, NTM earnings expectations are a powerful explanatory basis of valuation.

Chart 1

From this regression we can also infer the implied cost of equity. Chart 2 shows the year-to-date daily evolution of the market’s implied cost of equity for US bank stocks as well as the regression’s r squared. The regression r squared can be viewed as a proxy of the market’s confidence in analyst earnings expectations where a higher r squared infers higher confidence in reported consensus earnings expectations. For example, Chart 2 clearly demonstrates the impact of SIVB’s failed recapitalization on market perceptions. The sharp rise in implied cost of equity and coincidental drop in r squared post March 8, reflected the rise in fear and decline in confidence in analyst estimates. Markets’ confidence slowly recovered as analyst revisions came in and eventually the cost of equity receded. This explains the rally in valuations through 2Q23 earnings season despite downward earnings revisions post March 8th.

Of more interest to us is the trend post 2Q23 earnings season. As evident in Chart 2, market implied cost of equity has been rising since the beginning of August while earnings expectation confidence (i.e. regression r squared) is essentially unchanged. As shown in Chart 3, the rising cost of equity since early August, unlike the post March 8^th episode, was also not accompanied by a commensurate fall in the regression coefficient for slope.  For us, rising cost of equity, without concurrent material declines in r squared and the slope suggests that the market’s risk off move on US bank stocks is being driven by macro factors. We expect this trend to continue into the commencement of 3Q23 earnings season in October and contribute to further downward analyst earnings revisions. Both expectations underpin our decision to continue with our modest net short position adopted at the beginning of August.

Chart 2

Chart 3

[1] A universe of 325 bank stocks which have at least 1 sell side analyst providing a NTM earnings estimate. We then systematically exclude those outliers whose P/fwd. TCE or ROTCE exceeds +/- 2.5 Std Deviations from the daily median which produces a trimmed universe of 232 US bank stocks.