JPMorgan Chase (NYSE:JPM) has been a major beneficiary of the stock market rally following the 2016 election.
Since this time last year, shares of the New York City-based bank are up 44%. That’s more than twice the S&P 500. It also comes in ahead of other large-cap banks, with the KBW Bank Index returning 38% over the same stretch.
Given this performance, it’s reasonable for investors to ask this question: Is JPMorgan Chase’s stock cheap or expensive?
JPMorgan Chase’s price-to-book value ratio
A common way to measure a bank stock’s valuation is to use the price-to-book value ratio, which 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 to be worth on its balance sheet.
A bank with a ratio above 1.0 is said to trade for a premium to book value. The implication is that investors think the bank will create value beyond its current net worth.
Conversely, a bank that trades for less than book value per share is said to trade at a discount to book value. This implies that investors expect the bank’s value to erode — perhaps as a result of excess unrecognized loan losses.
In the case of JPMorgan Chase, its stock trades for 1.49 times its book value per share. That equates to a 49% premium to book value.
Despite this, compared to other bank stocks, JPMorgan Chase stock doesn’t come across as expensive. The median valuation on the KBW Bank Index is 1.41 times book value, or only eight basis points less than JPMorgan Chase.
JPMorgan Chase’s price-to-earnings ratio
A second way to measure a bank’s valuation is to use the price-to-earnings ratio, or P/E ratio. You calculate this by dividing a bank’s share price by its earnings per share.
The P/E ratio reflects how much it costs an investor to buy $1 worth of a company’s earnings. If the P/E ratio is 20, then it costs $20. If the ratio is 9, it costs $9.
There is no general industry benchmark in terms of what constitutes a high or low P/E ratio for a bank stock. That said, one can compare a bank stock’s P/E ratio to stocks that are both 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.
In JPMorgan Chase’s case, its stock trades for 14.2 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 this measure, then, JPMorgan Chase’s stock seems cheap, at least on a relative basis.
Something to keep in mind
While bank stocks like JPMorgan Chase may not have rich valuations right now, that doesn’t mean they can’t drop by a large margin; they can. One could make the argument, in fact, that stocks more broadly are in jeopardy of a correction 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 doesn’t hurt to buy one like JPMorgan Chase, which has a reputation for being superbly managed and which trades at a reasonable valuation.
John Maxfield has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.