But what could drive the upside beyond just having to hold large amounts of capital?
A “conglomerate discount” in investing offers large companies with a variety of business lines trade at a discount to peers. That’s because large cumbersome businesses are more complex, harder to manage and tougher for investors to evaluate.
So, what drives the upside is not just higher returns on equity for smaller banks, but also what Goldman calls “multiple re-rating.” It means that the banks would trade at higher price-to-earnings and price-to-book ratios if they were smaller.
When looking at potential bank breakups, it is best to focus on names that have strong individual businesses. It doesn’t make sense to split up a bank if the individual business lines won’t be able to stand on their own.
In closing: All three banks discussed here are large, cumbersome banks that would be best served broken up. And they all have solid individual businesses that could survive in the market standing alone. What’s more, the current valuations on these banks are also very enticing, with the three banks from above, trading at or below book value. Even without major breakups, these banks will perform well as long as the economy continues to strengthen.
This article is brought to you courtesy of Marshall Hargrave from Wyatt Research.