Before I decide whether to buy a bank’s shares, I always like to look at its return on equity and its core tier 1 capital ratio.
These core financial ratios provide an indication of how successful a bank is at generating profits using shareholders’ funds, and of how strong its finances are. As a result, both ratios can have a strong influence on dividend payments and share price growth.
Today, I’m going to take a look at the eurozone’s largest bank, Banco Santander S.A. (LSE: BNC) (NYSE: SAN.US), to see how attractive it looks on these two measures.
Return on equity
The return a company generates on its shareholders’ funds is known as return on equity, or ROE. Return on equity can be calculated by dividing a company’s annual profit by its equity (i.e, the difference between its total assets and its total liabilities) and is expressed as a percentage.
Santander’s return on equity has declined steadily since 2008 — perhaps what’s more surprising is that it has managed to make a decent profit throughout that time, despite some writing off €60bn in bad loan provisions over the last four years:
| Banco Santander | 2008 | 2009 | 2010 | 2011 | 2012 | Average |
|---|---|---|---|---|---|---|
| ROE | 15.2% | 14.1% | 11.4% | 7.1% | 2.9% | 10.1% |
How does Santander compare?
One way of assessing a bank’s risk is with its core tier 1 capital ratio, which compares the value of the bank’s retained profits and equity with its loan book.
In the table below, I’ve listed Santander’s core tier 1 capital ratio, ROE and price to tangible book value, alongside those of the two UK banks with the biggest exposure to the Americas, Santander’s key foreign market:
| Company | Core Tier 1 Ratio | Price to tangible book value | 5-year average ROE |
|---|---|---|---|
| Barclays | 11.1% | 84% | 6.0% |
| HSBC Holdings | 12.7% | 131% | 7.6% |
| Banco Santander | 11.1% | 152% | 10.1% |
Santander’s main attraction for most investors is its €0.60 annual dividend, which is expected to be maintained this year, giving a stunning 9.4% prospective yield.
The bank’s price-to-book-value ratio of just 75% also seems attractive — until you strip out goodwill and intangible assets. This leaves the bank’s shares with a price to tangible book value ratio of 152%, far higher than any of its UK peers.
Is Santander a buy?
Santander’s non-performing loan rate is still rising, and I suspect that some of the bank’s assets could suffer further impairments.
I’m not sure that Santander’s shares deserve to trade at such a high premium to their tangible asset value, and I suspect that their high yield is probably a big support for the bank’s share price.
For me, this makes Santander shares too risky, so I rate them as a cautious hold.
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> Roland owns shares in HSBC Holdings but does not own shares in any of the other companies mentioned in this article.
