Analysing Banking Stocks

Banks are institutions which are part of our daily lives. We have been witnessing growth in the size of the industry (many new players have entered in the past 10 years) and quality of services (more branches, better cust0mer dealings, internet banking & plastic money, improved loan and deposit products). In a sense, we have known how the industry has moved from a typical sarkari sector to a globally competitive playfield.

In this article, let us just look a bit deeper to how banking sector can be used for investment, by way of stocks.  Many schedules banks are listed in India which makes it easier for us to compare their performance and know about the industry features. To begin with the analysis, it is convenient to understand the income & expenditure concepts and key ratios of banks.

CASA (Current Account Savings Account): People & institutions place money (Deposit) with a bank for a certain period and/or earn interest/avail services. Deposits can be Demand Deposits, Savings Bank Deposit & Term Deposit. Out of the total deposits that customers have kept with the bank, savings accounts cost just 3.5% to and current accounts are charged to the customers for services provided by the bank, whereas the term deposits (FD, RD, etc.) cost higher. Funds from any type of deposit are lent by bank at much higher rate. Therefore, the bank which has higher proportion of savings & current accounts money out of the total deposits is in a more profitable position from the one whose deposits consist more of term deposits. Industry measures this feature of a bank as CASA Ratio i.e. amount of savings and current accounts as a percentage of total deposits held with the bank.

NPAs (Non-Performing Assets): Banks lend to earn interest. Lending by banks is governed by regulations of RBI & its own lending policy mainly. Banks are required to do thorough due diligence before accepting the lending proposal. NPAs are such advances of a bank which have ceased to provide income to the bank. RBI stipulates a period of 90 days for identification of NPAs. NPAs could either become good entirely or partially or may result in 100% loss to the bank. Provisions are created as per RBI guidelines for NPAs. The lower the quantum of NPAs, the better.

NIM (Net Interest Margin): This is the ratio of net interest earned (Interest earned – Interest paid) by the bank as a % of interest-earning assets i.e. advances. The ratio helps us in assessing the efficiency of the bank. More NIM, better.

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Many other ratios like ROI, ROA, ROE, operating margins, etc. can’t be ignored.

Honestly, I haven’t seen banks moving up and down according to their fundamentals. Also there is no guarantee that stocks bought based on such analysis will yield green figures in your portfolio statement.  But when we are in the market to buy shares without exactly knowing which stocks will be profitable, isn’t better to buy shares with strong fundamentals. SBI being the largest bank of India by assets. This feature of SBI is enough to make it a strong stock. Now even if an investor is having a long position in SBI at a price much higher than the prevailing market price, he can be reasonable assured that he has his money in a safe bet.

Graham on investing

The key requirement here is that the enterprising investor concentrate on the larger companies that are going through a period of unpopularity. While small companies may also be undervalued for similar reasons, and in many cases may later increase their earnings and share price, they entail the risk of a definitive loss of profitability and also of protracted neglect by the market in spite of better earnings. The large companies thus have a double advantage over the others. First, they have the resources in capital and brain power to carry them through adversity and back to a satisfactory earnings base. Second, the market is likely to respond with reasonable speed to any improvement shown.

Value Investing

Markets have been like weather in Delhi. Sometimes rising more than 100 points in a day (becoming hot) and falling by a similar score the next day (chiller). Correction of about 9% in Nifty and more than 15-30% in most blue-chip stocks.

As an investor, there are two most important things to think - where will the markets move and how will the stocks in portfolio behave. The first part is something which an investor is not much worried about as he takes investment decision based on facts and not predictions alone. Predicting the market behavious is not only dicey but can be a costly affair as even though our prediction, about market and stocks, is correct but when will the market reflect that prediction into prices is also unknown.

Value investing has been defined by countless investors and academicians. For me, what little I know about investing, VALUE INVESTING is investing in stocks that provide enough evidence of the value that an investor finds has been ignored by the market. As one might comment, it is easier to define than to practice. Being a investor with very modest investments and understanding, still I find that when the decades old rules are applied to investing, it can fetch descent returns (more than a FD) with lower risk. But value investing does not at all mean investing in all low P/E, low P/BV stocks or those stocks which have fallen by 50% or more during the year.

Important for us to understand is that markets can misprice stocks despite existence of FIIs, IIs, DIIs, analysts, etc. And the most common reason which I see for such mispricing is that so many people are analysing stocks with borrowed beliefs. If the financial TV channels and reports say that infra sector shall not do well, then majority of us buy such analysis. Result is that the stocks get the beating much more than what is deserved. Similar happend with IRB (went down to 158; already recovered by 17%), JP Associates (72.35; 16%), L&T (1487; 8%). People said so about Banking and NBFC sector also with outlook of tight liquidity and rising cost of borrowing. Kotak Mahindra Bank (339; 20%) IDFC (123; 10%). Now it is very easy and comforting in the hindsight to find out such stocks which got a market thrashing and recovered. It is easier to show astronomical returns by using their lowest price during the period of analysis. However, one can agree that such stocks are fundamentally good businesses with able management and a strong track record of performance. Even though, such stocks in similar businesses did not yield much till now but an investor can be assured of their recovering in the next 3-12 months.

Not complicating the concept, Value investing for me is to look for great (in terms of size, history) business and attractive price, price which one without going into valuation model finds too low for the Company. Maybe because of the peer comparision or due to stock's own historical prices. Using the 52 week low price or P/E or P/BV can be a helper.

Still the probability of suffering losses can't be eliminated but idea is to minimize the probability of losses.

Using nifty sparks, one can easily find stocks that are down in the past 30 days and a comparision with their 365 days prices is also provided. Another benefit of using sparks is that the stocks shown are included in indices which assures liquidity of stocks.