The Valor Blog.
Investment News and Views, Direct from Our Team.

What return on equity will banks have over the coming decades?

Banks have had periods in their history where they have posted excellent returns on equity for a number of years. Buying a bank when it has had 20% returns on equity for a number of years at over 2 times book value may work out ok, but unfortunately I think that this strategy ignores the downside risk.

I would suspect that banks returns on equity are likely to be closer to 10% than 20% over the very long term. If you want to at least make high single digit returns for your risk, then you should be paying no more than about 1.5 times book value for your banks. You should also factor whether you are paying 1.5 times book value at the top or bottom of the cycle. At the bottom of the cycle, book value would be marked down by loan losses. Are loan losses higher or lower than long term averages at present? If the loan losses are lower than long term averages, then your book value might be slightly optimistic.

At 2.99 times book for CBA, 2.31 for WBC, 2.09 for ANZ and 1.93 for NAB, I am not sure you are making a reasonable estimation of returns versus risk. Continued betting on these sort of metrics are unlikely to be wonderful long term investments.

We are investing in banks at closer to the bottom of their cycles at around 0.7 times book. A basket of these investments have significantly higher probabilities of making reasonable returns over the long term.