An approach to shortlist banks for valuation using P/B, ROE and Risk from NIFTY Bank
Valuation of banks is tricky. Debt is used as a raw material and used further for lending purposes. Consequently, equity becomes intrinsic to valuation. Professor Ashwath Damodaran captures this beautifully in his blog post early May '23 (link here). He also explain why Price to Book is relevant multiple in this industry.
I replicate the screener Professor Damodaran created to shortlist for 25 largest US banks and apply the logic to the stocks in Bank Nifty. I use annual reports of FY22 for the data.
Approach
I make the following changes to Professor Damodaran’s screener.
Use of Net Interest Margin in place of Interest Spread
Addition of CASA ratio as an indicator for low-cost deposit
Addition of Gross NPA as a 3rd measure of riskiness
For each variable, I take the median and then compare the value of the variable for each bank with that of the median. I highlight the better values in green.
Take-aways
We would obviously want to select banks that have green for all variables. In the absence of that, we make a judgmental call.
The right sub-set to select from the screener would depend on the investment objective and involve a tradeoff between cheapness (P/B) and profitability (ROE) and riskiness.
Next Step
Valuation for shortlisted bank(s) based on investor’s criteria. I like Federal Bank and IDFC First and would select one for valuation.
Assumption
This screener assumes other variables – quality of management, strategy for growth, etc – are not differentiators. Rather they reflect in these variables.
Interesting analysis