An overview of the core objectives of corporate management and how they are measured

 The primary aim of management is to increase

• the book value and 
• market value of the company.

Book Value

Book value (shareholders' equity on the company's balance sheet) is calculated as total assets less total liabilities.

It reflects the historical operating and financing decisions made by the company.

Management can directly influence book value (e.g., by retaining net income).


Market Value

However, management can only indirectly influence a company's market value.

Market value of a company is primarily determined by investors' expectations about the about, timing and uncertainty of the company's future cash flows

A company may increase its book value by retaining net income, but it will only have a positive effect on the company's market value if investors expect the company to invest its retained earnings in profitable growth opportunities.

If investors believe that the company has a significant number of cash flow generating investment opportunities coming through, the market value of the company's equity will exceed its book value.



Price to book ratio (market to book ratio)

A useful ratio to evaluate investor's expectations about a company is the price to book ratio.

If a company has a price to book ratio that is greater than industry average, it suggests that investors believe that the company has more significant future growth opportunities than its industry peers.

It may not be appropriate to compare price to book ratios of companies in different industries because the ratio also reflects investors' growth outlook for the industry itself.


Accounting Return on Equity

An important measure used by investors to evaluate the effectiveness of management in increasing the company's book value is accounting return on equity.

https://myinvestingnotes.blogspot.com/2017/04/primary-aim-of-management-is-to.html

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This is an overview of the core objectives of corporate management and how they are measured. Let's break it down, discuss the implications, and provide a summary.

Analysis & Discussion

The text correctly identifies a fundamental tension in management: the direct control over book value versus the indirect, influence-driven relationship with market value. This is the heart of modern financial management.

1. The Dual Aims: A Hierarchy, Not an Equality
While both are aims, increasing market value is the primary, ultimate goal in shareholder-oriented capitalism. Increasing book value is often a means to that end, but not an end in itself. The text makes this clear:

• Book Value is Backward-Looking & Controllable: It's an accounting cumulative snapshot. Management can boost it directly by retaining earnings (instead of paying dividends) or issuing new equity. However, this action in isolation has no intrinsic merit.

• Market Value is Forward-Looking & Judgment-Based: It represents the collective present-value judgment of all investors on the future use of those retained earnings and assets. Management influences this through strategic decisions, communication (guidance), and track record.

2. The Critical Bridge: Investment in Positive-NPV Projects
The key insight is the condition under which increasing book value also increases market value: only if retained earnings are invested in profitable growth opportunities (i.e., projects with a return exceeding the cost of capital).

• Example of Failure: A mature company with no growth opportunities retains earnings, increasing book value. If investors believe this cash will be spent on low-return projects or sit idle, the market value will stagnate or even fall. The increase in book value is seen as destroying value by denying shareholders the chance to invest the dividends elsewhere.

• Example of Success: A tech company retains earnings to fund R&D for a promising new product. Investors anticipate high future cash flows, so market value rises in anticipation, often well before the book value reflects the investment.

3. Price-to-Book (P/B) Ratio: The Indicator of Expectations
The P/B ratio perfectly encapsulates this dynamic:

• P/B > 1 (especially above industry average): The market believes the company's assets (and future investments) will generate returns above their accounting (historical) cost. This reflects intangible value—brands, patents, human capital, strategic position—and expected growth. This is typical for technology, pharma, and consumer goods companies.

• P/B ≈ 1 or < 1: Suggests the market sees the company as a "cash cow" with limited growth, or potentially one that is inefficiently deploying its assets. It is common for capital-intensive, slow-growth, or distressed industries (e.g., utilities, traditional manufacturing). A P/B < 1 can signal a value opportunity or fundamental problems.

4. Return on Equity (ROE): The Engine for Book Value Growth
Accounting ROE (Net Income / Shareholders' Equity) is rightly highlighted as the metric for how effectively management uses book value.

• Link to Growth (Sustainable Growth Rate): A high ROE, when earnings are retained, allows for faster organic growth of book value. The formula Sustainable Growth Rate = ROE * Retention Ratio demonstrates this directly.

• The Crucial Caveat: ROE is an accounting measure and can be manipulated (via leverage, accounting choices). A high ROE driven by excessive debt increases risk. Therefore, investors look at both the level and the quality of ROE. The ultimate test is whether a high ROE leads to an increasing P/B ratio and market value.

Critical Comments & Nuances

1. Limits of Book Value: In today's knowledge economy, book value is increasingly disconnected from real economic value. It ignores key assets like intellectual property, brand equity, and data, while often carrying assets at historical cost.

2. Market Value Short-Termism: While market value is the goal, its short-term fluctuations can pressure management into decisions that boost quarterly earnings at the expense of long-term value creation (e.g., cutting R&D).

3. Industry Context is King: Comparing P/B or ROE across industries is often meaningless. A utility with a stable P/B of 1.2 and ROE of 9% might be excellently managed, while a software company with the same stats would be considered a failure.

4. Other Stakeholders: This framework is purely shareholder-centric. Modern governance also considers stakeholders (employees, community, environment), which can influence both book value (e.g., through ESG investments) and market value (through reputation and license to operate).

Summary

Management's primary aim is to maximize shareholder wealth, best represented by the company's market value. To achieve this:

• Book Value is the accounting foundation, representing accumulated capital. Management can increase it directly, but this only matters if the capital is deployed wisely.

• Market Value is the ultimate scorecard, reflecting investors' faith in management's ability to generate future cash flows from current and future assets.

• The Price-to-Book (P/B) Ratio measures the gap between these two values. A high P/B indicates the market expects management to earn super-normal returns on the company's asset base.

• Accounting Return on Equity (ROE) is the key internal metric for assessing how efficiently management generates profits from the book equity. It fuels book value growth, but only translates into market value growth if the profits are sustainable and from value-creating projects.

In essence, successful management is about investing retained earnings (and other capital) into projects whose expected returns are significantly above the cost of capital. This drives up ROE, which, if sustainable and recognized by the market, leads to a high and increasing P/B ratio and, consequently, the maximization of market value. The art of management lies in executing this while balancing short-term expectations with long-term strategy and broader stakeholder considerations.

Investor's Checklist: Banks

 

Sunday, 16 May 2010   

https://myinvestingnotes.blogspot.com/2010/05/investors-checklist-banks.html

INvestor's Checklist: Banks

1.  The business model of banks can be summed up as the management of three types of risk:  

• credit, 
• liquidity and 
• interest rate.

2.  Investors should focus on conservatively run institutions.  They should seek out firms that hold large equity bases relative to competitors and provision conservatively for future loan losses.

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Excellent checklist. This excerpt from Pat Dorsey's The Five Rules for Successful Stock Investing provides a concise, powerful framework for analyzing banks. Let's break it down, discuss its strengths and add necessary context.

Summary & Core Thesis

Dorsey argues that bank investing is fundamentally about analyzing risk management. A good bank isn't just about profit growth; it's a conservatively-run institution that expertly navigates credit, liquidity, and interest rate risk to generate steady returns across economic cycles. The checklist emphasizes quality (conservatism, competitive advantages), financial discipline (asset-liability matching), and valuation (price-to-book).

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Analysis & Discussion of Key Points

1. The Three-Risk Model (Credit, Liquidity, Interest Rate):
This is the foundational insight. Everything flows from here.

• Credit Risk: The risk loans won't be repaid. This is where most bank failures begin (e.g., the 2008 crisis, regional bank crises driven by bad CRE loans). Dorsey's emphasis on conservative provisioning is key—it shows a bank is realistic, not optimistic, about its loan book.

• Liquidity Risk: The risk a bank can't meet short-term obligations. This is what causes runs (e.g., Silicon Valley Bank, 2023). A bank can be solvent (assets > liabilities) but fail if it can't access cash.

• Interest Rate Risk: The risk that changing rates will hurt profitability. If a bank funds long-term, fixed-rate loans with short-term deposits, rising rates crush its net interest margin (NIM). Point #4 on duration matching is the direct prescription for this risk.

2. The Emphasis on Conservatism:
This is the most crucial takeaway for an investor. In a leveraged, risk-taking business, survivors are conservative. A "large equity base" (high capital ratios) is a buffer against losses. Conservative provisioning builds reserves in good times for the bad times. This discipline often means slightly lower returns in booms, but ensures survival and market share gain in busts.

3. Competitive Advantages (The "Moat"):
Dorsey's list is spot-on and explains why good banks are phenomenal businesses:

• Cheap Funding: The ability to take insured deposits is a huge, government-backed advantage.

• Economies of Scale & Network: A branch network is expensive to build and creates a local oligopoly.

• High Switching Costs: Changing your business checking, payroll, and credit lines is a massive headache.

• Capital Intensity & Limited Exit Barriers: It's hard to start a bank, but easy to sell a loan book or the whole bank. This reduces "do-or-die" competition.

4. Financial Metrics (ROE, ROA, Price-to-Book):

• ROE & ROA: For banks, these must be evaluated together. A very high ROE driven by extreme leverage (low equity base) is dangerous. A solid ROA (e.g., consistently >1%) indicates true operational efficiency.

• Price-to-Book (P/B): The go-to metric because bank assets and liabilities are mostly marked-to-market or held at values close to book. However, P/B must be used in context. A bank trading at a low P/B might be cheap, or it might be a value trap with a hidden, deteriorating loan book. A high-quality bank with a high ROE and low risk often deserves a higher P/B multiple.

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Critique & Modern Context

While timeless, the checklist needs some updating for the post-2008/GFC and post-2023 (SVB) world:

1. Regulatory Environment is Crucial: Dorsey's era was pre-Dodd-Frank. Today, an investor must understand a bank's regulatory status (e.g., GSIB, CCAR stress testing for large banks). Capital requirements (CET1 ratio) are now a non-negotiable metric.

2. Liquidity is Even More Prominent: The SVB collapse put a laser focus on liquidity coverage ratios (LCR) and the dangers of holding long-dated securities (HTM vs. AFS portfolios) in a rising rate environment. Duration matching (#4) is now a survival issue.

3. Fee Income & Diversification: The checklist implicitly focuses on traditional lending. Today, the mix of revenue matters. Reliance on volatile investment banking or trading fees adds another layer of risk. Stable, "sticky" fee income (e.g., wealth management, custody) is highly valuable.

4. Technology as Moat & Threat: An "established distribution network" (branches) can now be a liability if it's not paired with robust digital banking. Fintechs are eroding certain profitable niches (payments, lending). Tech spend is now a key competitive factor.

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Updated Investor Checklist (Synthesizing Dorsey & Modern Insights)

1. Risk Management Culture First: Look for conservative underwriting, prudent provisioning (allowance for loan losses relative to NPAs), and a management team that discusses risk with clarity and fear.

2. Strong, Clean Capital & Liquidity: Analyze CET1 Ratio (well above requirements) and Liquidity Coverage Ratio. Scrutinize the securities portfolio—is it dangerously mismatched with deposits?

3. Steady, Diversified Earnings: Seek consistent growth in Pre-Provision Net Revenue (PPNR)—profit before loan losses. This shows core strength. A healthy mix of net interest income and stable fee income is ideal.

4. Proven Through the Cycle: Examine performance during the last recession (2008-09) and the 2020/2023 volatility. Did the bank remain profitable? Did its capital base hold up?

5. Valuation in Context: Use P/B relative to ROE and risk profile. Compare a bank's P/B to its own historical average and to peers with similar ROE and asset quality. A high-quality bank at a moderate P/B is better than a risky bank at a low P/B.

Final Comment

Pat Dorsey's checklist remains one of the best starting points for understanding bank investing. Its core principles—conservatism, risk management, and valuing a bank as a steward of risk rather than a pure growth engine—are timeless. The modern investor's task is to apply these principles using the enhanced regulatory and analytical tools developed since the book's publication, with a heightened focus on liquidity and the technological landscape. By doing so, they can identify those rare institutions that are not just banks, but durable, high-quality compounders.

Primary aim of management is to increase the book value and the market value of the company.

The primary aim of management is to increase

• the book value and 
• market value of the company.

Book Value

Book value (shareholders' equity on the company's balance sheet) is calculated as total assets less total liabilities.

It reflects the historical operating and financing decisions made by the company.

Management can directly influence book value (e.g., by retaining net income).


Market Value

However, management can only indirectly influence a company's market value.

Market value of a company is primarily determined by investors' expectations about the about, timing and uncertainty of the company's future cash flows

A company may increase its book value by retaining net income, but it will only have a positive effect on the company's market value if investors expect the company to invest its retained earnings in profitable growth opportunities.

If investors believe that the company has a significant number of cash flow generating investment opportunities coming through, the market value of the company's equity will exceed its book value.



Price to book ratio (market to book ratio)

A useful ratio to evaluate investor's expectations about a company is the price to book ratio.

If a company has a price to book ratio that is greater than industry average, it suggests that investors believe that the company has more significant future growth opportunities than its industry peers.

It may not be appropriate to compare price to book ratios of companies in different industries because the ratio also reflects investors' growth outlook for the industry itself.


Accounting Return on Equity

An important measure used by investors to evaluate the effectiveness of management in increasing the company's book value is accounting return on equity.



Read also:  https://myinvestingnotes.blogspot.com/2025/12/an-overview-of-core-objectives-of.html

Investor's Checklist: Banks

1.  The business model of banks can be summed up as the management of three types of risk:  

• credit, 
• liquidity and 
• interest rate.

2.  Investors should focus on conservatively run institutions.  They should seek out firms that hold large equity bases relative to competitors and provision conservatively for future loan losses.

3.  Different components of banks' income statements can show volatile swings depending on a number of factors such as the interest rate and credit environment.  However, well-run banks should generally show steady net income growth through varying environments.  Investors are well served to seek out firms with a good track record.

4.  Well-run banks focus heavily on matching the duration of assets with the duration of liabilities.  For instance, banks should fund long-term loans with liabilities such as long-term debt or deposits, not short-term funding.  Avoid lenders that don't.

5.  Banks have numerous competitive advantages.  They can borrow money at rates lower than even the federal government.  There are large economies of scale in this business derived from having an established distribution network.  The capital-intensive nature of banking deters new competitors.  Customer-switching costs are high, and there are limited barriers to exit money-losing endeavors.

6.  Investors should seek out banks with 

• a strong equity base, 
• consistently solid ROEs and ROAs, and 
• an ability to grow revenues at a steady pace.

7.  Comparing similar banks on a price-to-book measure can be a good way to make sure you're not overpaying for a bank stock.


The Five Rules for Successful Stock Investing
by Pat Dorsey

Click here for more discussion on this topic:

https://myinvestingnotes.blogspot.com/2010/05/investors-checklist-banks.html

What should investors look for when investing in banks and other financiers?

What should investors look for when investing in banks and other financiers?

Because their entire business - their strengths and their opportunities - is built on risk, it's a good idea to focus on conservatively managed institutions that consistently deliver solid - but not knockout - profits.  Here's a list of some major metrics to consider.

Strong Capital Base

A strong capital base is the number one issue to consider before investing in a lender.  Investors can look at several metrics.

• The simplest is the equity to assets ratio; the higher, the better.  The level of capital should vary with each institution based on a number of factors including the riskiness of its loans.  Most of the bigger banks have capital ratios in the 8% to 9% range.  
• Also look for a high level of loan loss reserve relative to nonperforming assets.

These ratios vary depending on the type of lending an institution does, as well as the point of the business cycle in which they are taken.

Return on Equity and Return on Assets

These metrics are the de facto standards for gauging bank profitability.  

Investors should look for banks that can consistently generate mid- to high- teen returns on equity.  

Ironically, investors should be concerned if a bank earns a level not only too far below this industry benchmark, but also too far above it.  After all, many fast-growing lenders have thrown off 30% or more ROEs, just by provisioning too little for loan losses.  Remember, it can be very easy to boost bank's earnings in the short term by under-provisioning or leveraging up the balance sheet, but this can be unduly risky over the long term.  For this reason, it's good to see a high level of return on assets, as well.

For banks, a top ROA would be in the 1.2 % to 1.4% range.

Efficiency Ratios

The efficiency ratio measures non-interest expense, or operating costs, as a percentage of net revenues.  

Basically, it tells you how efficiently the bank is managed.  Many good banks have efficiency ratios under 55% (lower is better).

Look for banks with strong efficiency ratios as evidence that costs are being kept in check.

Net Interest Margins

Net interest margin looks at net interest income as a percentage of average earning assets.

Virtually all banks report net interest margins because it measures lending profitability.  

You'll see a wide variety of net interest margins depending on the type of lending a bank engages in, but most banks' margins fall into the 3% to 4% range.  

Track margins over time to get a feel for the trend - if margins are rising, check to see what's been happening with interest rates.  (Falling rates generally push up net interest margins.)

In addition, examine the bank's loan categories to see whether the bank has been moving into different lending areas. For example, credit card loans typically carry much higher interest rates than residential mortgages, but credit card lending is also riskier than lending money secured by a house.

Strong Revenues

Historically, many of the best-performing bank investments have been those that have proven capable of above-average revenue growth.  Wide margins have generally been elusive in a commodity industry that competes on service quality.  But, some of the most successful banks have been able to cross-sell new services, which adds to fee income, or pay a slightly lower rate on deposits and charge a slightly higher rate on loans.

Keep an eye on three major metrics:
(1) net interest margin,
(2) fee income as a percent of total revenues, and
(3) fee income growth.

The net interest margin can vary widely depending on economic factors, the interest rate environment, and the type of business the lender focuses on, so it's best to compare the bank you're interested in to other similar institutions.  Fee income made up 42% of bank industry revenue in 2001 and has grown at an 11.6% compound annual rate over the past two decades.  As always, examine the number over a  period of time to get a sense of the trend.

Price to Book 

Because banks' balance sheets consist mostly of financial assets with varying degrees of liquidity, book value is a good proxy for the value of a banking stock.

Typically, big banks have traded in the two or three times book range over the past decade; regionals have often traded for less than that.

A solid bank trading at less than two times book value is often worth a closer look.  Remember, there is almost always a reason the bank is selling at a discount, so be sure you understand the risks.  On the other hand, some banks are worth three times book value or more, but we would exercise caution before paying that much.


The Five Rules for Successful Stock Investing
by Pat Dorsey


Summary:

Equity to assets ratio (capital ratio):  8% to 9% or greater
Loan loss reserve:  High level of loan loss reserve relative to nonperforming assets.
ROE: mid- to high- teen ROE
ROA:  1.2% to 1.4% or higher
Efficiency ratios = (noninterest expense or operating costs)/(net revenues):  < 55% (lower is better)
Net Interest Margins = net interest income / average earning assets:  3% to 4% range
Strong above-average Revenue growth: Look at net interest margin + fee income as percentage of total revenue + fee income growth
Price-to-Book:   Big banks often trade at P/B 2 x  to 3 x range.

Book value is a good proxy for the value of a banking stock.

Because banks' balance sheets consist mostly of financial assets with varying degrees of liquidity, book value is a good proxy for the value of a banking stock.  Assuming the assets and liabilities closely approximate their reported value, the base value for a bank should be book value.  

• For any premium above the book value, investors are paying for future growth and excess earnings.  
• Seldom do banks trade for less than book, but if they do, the bank's assets could be distressed.  
• Typically, big banks have traded in the two or three times book range over the past decades; regionals have often traded for less than that.

A solid bank trading at less than two times book value is often worth a closer look.

• Remember, there is almost always a reason the bank is selling at a discount, so be sure you understand the risks.  
• On the other hand, some banks are worth three times book value or more, but we would exercise caution before paying that much.  

Bank stocks are volatile creatures, and you can find good values if you're patient - especially because even the best banks will generally be hit hard when any high-profile blowup occurs in the financial services sector.  Lining up several banks for a relative P/B valuation isn't as good as putting together a discounted cash flow model, but for this industry, it can be a reasonable approximation of the value of the business.

These metrics should serve as a starting point for seeking out quality bank stocks.  Overall, we think the best defense for investors who want to pick their own financial services stocks is

• patience and 
• a healthy sense of skepticism.  

Build a paper portfolio of core companies that look promising and learn the businesses over time.  Get a feel for

• the kind of lending they do, 
• the way that risk is managed, 
• the quality of management, and 
• the amount of equity capital the bank holds.  

When an opportunity presents itself - and one always does - you'll be in a much better position to act.