Why is the increase in bank stock prices outstripping the increase in bank earnings? The fundamentals would seem to argue for more modest valuations.

The price of any stock depends on company profitability and growth (more precisely, on the return on equity relative to the required return or hurdle rate and the sustainable increase in retained earnings). To maintain their current ratios of market value to book value, the top 50 banks would seem to need record combinations of profitability and growth-for example, an 18% ROE and an 11% annual increase in earnings per share.

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