Are Shares of SunTrust Banks Cheap or Expensive?

10/25/17

By John Maxfield, MotleyFool

Shares of SunTrust Banks (NYSE:STI) are up 28% over the past year. That's less than many of its peers, as the KBW Bank Index has climbed 38% over the same stretch, but it nevertheless beats the S&P 500, which is up 20%.

Given this performance, it's reasonable for investors to ask: Are shares of SunTrust Banks cheap or expensive?

A branch of SunTrust Banks.

A BRANCH OF SUNTRUST BANKS. IMAGE SOURCE: GETTY IMAGES.

SunTrust Banks' price-to-book value ratio

A common way to gauge a bank stock's valuation is to use the price-to-book value ratio. This is calculated by dividing a bank's share price by its book value per share. This tells you how much investors think a bank is worth relative to how much the bank purports on its balance sheet to be worth on a per-share basis.

The calculation for the price to book value ratio.

If a bank has a price-to-book value ratio above 1.0, it's said to trade for a premium to book value. One way to interpret this is that investors believe the bank's business model will create value beyond its current net worth.

Alternatively, a bank that is priced below its book value per share is said to trade at a discount to book value, implying that investors expect the bank's value to erode -- possibly due to unrecognized loan losses.

A bar chart comparing seven banks' price-to-book value ratios.

DATA SOURCE: YCHARTS.COM. CHART BY AUTHOR.

SunTrust's stock trades for 1.27 times its book value per share. That equates to a 27% premium.

Still, if you compare SunTrust to other banks, its valuation seems very reasonable. The average bank stock on the KBW Bank Index is valued at 1.41 times its book value, or 14 basis points higher than the Atlanta, Georgia-based bank.

You would thus be excused for concluding that SunTrust's stock is still a bargain, at least compared to the two dozen other large-cap banks on the KBW Bank Index.

A line chart comparing SunTrust Banks' stock performance to the S&P 500.

DATA SOURCE: YCHARTS.COM. CHART BY AUTHOR.

SunTrust Banks' price-to-earnings ratio

A second way to determine a bank stock's valuation is to use the price-to-earnings, or P/E, ratio. You calculate this by dividing a bank's share price by its earnings per share.

The calculation for the price to earnings ratio.

The P/E ratio shows how much it costs an investor to buy $1 worth of a company's earnings. If the P/E ratio is 19, then it costs $19. If the ratio is 8, it costs $8.

There is no set-in-stone rule about what constitutes a high or low P/E ratio for a bank stock. That said, you can compare a bank's stock to stocks within the bank industry and outside of it -- this is a key benefit of the P/E ratio over the price-to-book value ratio.

A bar chart comparing SunTrust Banks' price-to-earnings ratio to the median on the KBW Bank Index and S&P 500.

*THE MEDIAN WAS USED FOR THE KBW BANK INDEX AND THE S&P 500. DATA SOURCE: YCHARTS.COM, THE WALL STREET JOURNAL. CHART BY AUTHOR.

In SunTrust's case, its stock trades for 15.9 times its earnings over the trailing 12 months. That compares to a median P/E ratio on the S&P 500, an index of large-cap stocks, of 23.2. The median on the KBW Bank Index is 16.8.

By both measures, then, SunTrust's stock seems cheap, at least on a relative basis.

A caveat is in order

Just because SunTrust's stock trades at a lower valuation than the typical bank stock in terms of the price-to-book value ratio as well as the P/E ratio doesn't mean that its stock can't drop by a large margin, because it can.

One could make the argument, in fact, that all stocks are in jeopardy of that right now, given the multiyear bull market in equities since the financial crisis. But holding all else equal, if you're going to buy a bank stock in this environment, it wouldn't hurt to buy one that's selling at a discount to others, as SunTrust Banks is.

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