Tuesday, April 23, 2024

How to Analyze Banking Stocks

Have you been considering the best banking stocks in India for your portfolio? While that is all very well, do you know the methods for analyzing these stocks? A knowledge-backed analysis mechanism is vital for making sure that you invest in the right banking stocks. There are many banks in the country, although not all of them are listed on stock exchanges. There are public sector, private sector, and small finance banks in the country. 

At the same time, banks have a business model which encompasses earnings from loan interest, charges for banking services and solutions, complimentary service charges, and so on. 

Analysis of banking stocks- Main ratios

Some of the key ratios for analyzing banking stocks include the following: 

  1. ADR (Advance Deposit Ratio) – This is a vital parameter that you can use for measuring all financial entities or institutions. This ratio indicates the total advances or loans to the total deposits of any banking institutions. This ratio will tell you about the abilities of the bank, with regard to utilization of funds which are available to it. You should choose a bank that has maintained an ADR on the lower side. While comparing the ADR across banking institutions, ensure that you are taking similar-sized banks (also of the same types) into account. 
  2. Equity Multiplier (EM) Ratio – This is a specific ratio that indicates the quantum of company assets which are financed with the equity of shareholders. The calculation formula is the following- EM = Total Assets / Total Shareholder’s Equity. If the ratio is lower for a bank, then it denotes that more equity is being tapped by the institution (than taking debt) for purchasing assets. Banks with lower ratios or EMs are always regarded as safer options, since they have lesser debt burdens alongside. Look for an EM figure within 15 while analyzing banking stocks. 
  3. Return on Assets (ROA) – ROA is a specialized calculation metric or parameter. It indicates the overall bank profitability in relation to its assets in total. The calculation formula is the following- ROA = Net Income or Total Assets. The higher this figure, the better your investing options are. This is because it clearly shows that the bank is earning a higher sum on lower investments. The business model of banks is reliant on deposits by the public. Hence, the ROA values are anyway on the lower side. The minimum ROA value of banks should stand at 1%. 
  4. ROE (Return on Equity) – These parameters denote the efficient performance of any business in terms of generating returns, with the help of funds taken from investors. The calculation formula is the following- ROE = Net Income / Total Equity of Shareholders. Most entities emphasize upon the earnings per share or EPS. ROE holds greater relevance for financial or banking institutions, since it may ensure a superior analysis of the market value or growth of banking institutions. The higher this ROE value, the better the chances of profitability for all shareholders. ROE which is higher than 15% is always acceptable in this regard. 

Analyzing Banking Stocks

The above-mentioned parameters will help you accurately analyze banking stocks and take informed decisions regarding performance and future prospects. You can get this information from several industry websites and magazines. Make sure that you stick to a certain threshold for the EM, ROE, and ROA values. The product value of the EM and ROA should not dip below the 15% ratio. If this goes downwards, then you should avoid stock investments in the banking entity as per a thumb rule. A higher NM is always coveted for any banking stock investor. 

You can also check out other aspects like the net and gross NPAs (non-performing assets) of banks, along with the capital adequacy and provisioning coverage ratios. This will help you put the bank’s present scenario into perspective. You can always take financial guidance before investing in these stocks. 

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