Corporations close to rock bottom

If investors lose confidence and can essentially no longer gauge what a company’s balance sheet is actually worth, companies or indeed sometimes entire sectors are valued with a clearly reduced price-to-book ratio (P/B ratio). This means that they are worth less on the stock exchanges than the equity capital on the balance sheet. Deutsche Bank, for example, is currently quoted at a very low price-to-book ratio of 0.2. That said, it is simply one extremely low value in the European banking sector per se, which as a whole has a very low P/B ratio.

This is, of course, not a unique case, and it also does not necessarily mean the end of a company. In the past, almost 30% of German corporates have been through a massive sag in their P/B ratios to <= 0.4 and almost 10% to <= 0.2, and have survived. This trend was to be seen particularly in periods of sharp collapses on the stock markets, such as after the dot-com bubble burst and during the 2008-9 financial and economic crisis. It bears saying however that both those phases were also systemic crises and could not be attributed to individual erroneous developments in sectors or specific companies.

Frequently, restructuring in connection with write-downs as well as capital increases were necessary to successfully turn the respective company around. In particular, corporations with high intangible assets had to make high write-offs. It was moreover helpful when business crunches and systemic challenges were solved fast. One trend also seen among some technology corporations was that the success of the technology gradually took off and as a result larger capital increases and write-downs were avoided.

The low P/B ratios for European banks are neither driven by an abrupt price collapse in the markets nor can they be solved by the swift success of a technology. The sector as a whole is suffering amongst other things from the low-interest regime, intense competition, and high costs from regulatory pressures. Things cannot be expected to change in this regard in the short or medium term. Furthermore, there are different, company-specific reasons for the low P/B ratios of European banks. Corporations are responding by lowering costs, modernising IT, founding so-called bad banks to wind down specific unprofitable activities, and seeking to increase their market share. The latter can also be achieved by mergers or acquisitions, which have to contend with high hurdles, as the recent failure of the merger of Deutsche Bank and Commerzbank showed. On balance, the sector needs a comprehensive agenda to get it fit in the long term. Otherwise valuations will continue to feature an appreciable markdown on the book value.

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