Lesson 6 of 6
Where the accounts are firmer
For a bank, book value is most of the market value and cash flow is close to meaningless. See the two cases side by side on filed figures.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- This method is strongest where book value is a large share of market value and weakest where it is a rounding item.
- For a bank, most of the balance sheet is financial instruments carried at or near a measured value, and free cash flow has no clean meaning.
- Price to book is the same model in disguise: it is a statement about the return a company will earn on its equity.
The method is the same everywhere. What changes is how much work the filed part does. Where book value carries most of the market value, the forecast is a small correction. Where book value is a rounding item, the forecast is the whole answer and the anchor was never an anchor.
How much of market value the balance sheet already explains
- U.S. Bancorp: book value as a share of market value67.3%
- The Coca-Cola Company: book value as a share of market value8.5%
Two companies, two jobs for the model
For the bank, 67.3 percent of what the market pays is already on the balance sheet and audited. The residual income stream has to explain the other third. For the drinks company, 8.4 percent is on the balance sheet and the stream has to explain more than nine tenths of the price. Same method, very different exposure to being wrong.
Where the accounts are firmer
- Banks and insurers: most assets and liabilities are financial instruments carried at or near a measured value.
- Equity is the regulated, reported quantity that management and supervisors both steer by.
- There is no meaningful free cash flow: lending more consumes cash and is the business working, not failing.
Where they are not
- Companies whose value is research, brands or software built internally and expensed as spent.
- Book value understates what was actually invested, so the return on it is overstated and the anchor is thin.
- A cash flow model has more to work with, because the cash is real even when the balance sheet is not.
The method does not change. What changes is how much of the answer the filing already contains.
Price to book, read as a forecast
That identity comes straight out of the residual income model with constant growth, and it turns a familiar ratio into a testable claim. The bank above traded at 1.49 times book in this site's catalogue. At a cost of equity of 10 percent and growth of 3 percent, a price to book of 1.49 requires a return on equity of 13.4 percent, sustained. That is a number a reader can check against ten years of filings.
The rule this leaves you with
Use the instrument whose anchored part is largest. That is a statement about the company, not a preference. It also explains why the same reader can reasonably run a discounted cash flow on one holding and a residual income model on the next one, and why the two should never be averaged into a single answer.
Check yourself
Why is free cash flow a poor instrument for a bank?
- Banks do not file cash flow statements
- Lending consumes cash, so the business growing looks like cash draining away
- Banks have no capital expenditure
Show the answer
Answer: B.
For a lender, the movement of cash is the product rather than a by-product, so the usual free cash flow subtraction does not describe anything an owner can spend.On the filed figures above, how much of the bank's market value was already on its balance sheet as book equity?
- 8.4 percent
- 67.3 percent
- 100 percent
Show the answer
Answer: B.
Book equity of 65,193 million dollars against a market capitalisation of 96.92 billion is 67.3 percent, so the forecast has to explain the remaining third.Read as the model, what does a price to book above 1 assert?
- That the shares are expensive
- That the company is expected to earn a return on equity above its cost of equity
- That the company has no debt
Show the answer
Answer: B.
The identity makes a price to book above 1 a claim about a positive spread between the return on equity and the charge, sustained long enough to matter.Sources
- U.S. Bancorp, Form 10-K for fiscal 2025, filed 2026-02-23, accession 0000036104-26-000011. Net income applicable to common and total shareholders' equity read from the SEC XBRL company facts API on 2026-09-13.
- The Coca-Cola Company, Form 10-K for fiscal 2025, filed 2026-02-20, accession 0001628280-26-010047.
- This site's company catalogue, built 2026-09-16 from prices last stored on 2026-09-15, for both market capitalisations and the published price to book.
- Penman, Financial Statement Analysis and Security Valuation, on when accounting-based valuation is on firmer ground than a cash flow forecast.
What this leaves out
- The bank's total equity includes preferred stock, so the 67.3 percent share and any return on common equity computed from it are approximations until the preferred is stripped out.
- Market capitalisations are stored figures from the date shown, not live quotes, and the shares of market value move with them.
- The price to book identity assumes constant growth and a constant return on equity, which no company delivers.
- Neither company here is being valued or recommended. Nothing on this page is advice.