Bank ROE Spread
The relationship between a bank's return on equity (ROE), its market-implied cost of equity (COE), and its price-to-book multiple. The algebra: P/B = (ROE - g) / (COE - g). Rearranging gives market-implied COE = (ROE - g) / (P/B) + g. A bank earning 14% ROE that trades at 1.6x P/B is signaling COE in the high single digits; a bank earning 8% ROE that trades at 0.6x P/B is signaling COE WELL ABOVE ROE (the textbook value-trap configuration). Reading the implied COE off the market is the cross-check that exposes whether your CAPM-built COE for a bank is internally consistent with how the equity is actually pricing.
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Related terms
Ambiguity Aversion · Anchored Assumption · Asset Beta · Banker Pitch Deck · Beta · Build-Up Method
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