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It’s pretty darn clear why you wouldn’t want to invest in Deutsche Bank (ETR: DBK).
The numbers tell at least half of the story. Between 2009 and today, the top line has barely moved, but pre-tax income is only a fraction of the profit of 2009 (forget 2006 profits!). Lower profits also means lower profit margins — the pre-tax return on equity for 2013 was only 2.6% compared to 15.3% for 2009. And although capital levels now appear relatively healthy, the bank brought in 8.5 billion euros in June through a massive new share issuance to strengthen its capital base. And this wasn’t even the first capital raise in the 2014.
But it’s not just the numbers. The legal picture isn’t great either. In the second quarter, the bank increased its provisions for settlements, thanks to, as CFO Stefan Krause put it, “the potential impact to the bank of recent settlements by others.” Krause tried to sound an optimistic tone, but there are still many uncertainties. As he noted:
It is in our interests to resolve these matters as swiftly as possible. However, there is significant uncertainty as to the timing and size of potential litigation impacts beyond our influence.
And lest we forget: As a result of the financial crisis, regulators have been watching the banks closely and have cooked up more stringent rules for them. It’s certainly not crazy to think that these rules could have a negative impact on bank profits.
All in all, it doesn’t sound like much of a pitch for owning Deutsche Bank’s stock, right?
But, but… it’s so cheap!
The typical method for valuing a bank is to use the price to book value ratio (P/BV). This simply takes the market price of bank divided by total equity of the bank. In general, a P/BV below one is attractive and a P/BV above two is considered not attractive (it’s not quite that simple, but that’s a topic for another article). And where do we see the P/BV of Deutsche Bank today? According to Standard & Poor’s Capital IQ, it stands at just 0.52.
This is not only low, that is crazy low.
Cheapness alone, however, isn’t an adequate reason to buy a stock. If you buy a stock just because it’s cheap, you may be becoming the (not so) proud co-owner of a bad company. That is, a company with a lousy market position, without compelling products, and with disappointing outlook. In short: Not something that we want.
But sometimes a stock can be cheap because investors are worried about the above, even if those concerns are not fully justified. Those situations can be great buying opportunities. Over time, investors can use these opportunities to benefit from both the company’s growth and the rise of the P/BV multiple.
So then, Deutsche Bank: Is it undervalued, or not?
Deutsche Bank had a solid second-quarter report. But we shouldn’t place too much importance to a single quarter. The concerns I listed at the outset of this article are genuine and there’re some pretty big hurdles for the bank to overcome.
That said, we can say with pretty high confidence that the concerns for Deutsche Bank are already priced into the share price. A P/BV ratio of 0.5 is extremely low and suggests that there are many recognized concerns around the bank. With such a low multiple already, there is little room for further pessimism. On the other hand, even there is even just a faint glow of some optimism…
But again, it’s not just the low valuation. Deutsche Bank is one of the largest banks in the world. Think about that for a moment. You can’t build a bank like that, with that kind of market position, overnight. And with a global presence there come many advantages, including a favorable financing, customer relationships, and brand awareness. And while that’s important outside Germany, it is even more important within Germany, where it’s the largest bank.
Size, though, is not enough to make a company a good investment. Many large companies have been bad investments. But it may be a little different from banks. Huge banks live and die with the economy of their home country. Sure, Deutsche Bank has to overcome hurdles. But the German economy is a strong economy, and one that I strongly believe in over the long term.
Combine these three elements — low price, a difficult-to-attain market position, and a home in one of the strongest economies in the world — and I see the opportunity for a good investment.
I’m not quite ready to buy shares of Deutsche Bank. Before I buy a stock, I like to take the time for a close look of various factors, including leadership, strategy, and competition. But not all companies seem attractive enough that I want to take the time for this further research. But Deutsche Bank is one such company.
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