Seeking Value in Private Banks

Are private banks set to perform?

Hi,

Last week we wrote on how the spread between NIFTY 500 earnings yield and the US10Y was negative, which since then has narrowed.

Where does NIFTY 500 stand with the US 10Y hitting ~5%?

This week we are going a little deeper on the valuations of Private Banks and how are they placed to do in the coming year.

Let’s Begin

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Setting the Context

Taking the past 15 years data of NIFTY Private Bank’s Price-to-book and it’s next 252 day cumulative return (i.e ~1 Year forward return), the relationship shows a strong negative correlation of 0.85, i.e, they have a solid inverse relationship

Exhibit A: NIFTY Private Bank P/B and the next 252 day cumulative return

As you can see above, as the NIFTY PB crosses 3.5x, the next 1Y returns for NIFTY private banks have been negative where as if they fall below 2.3-2.4x, the return has been positive.

Exhibit B: NIFTY Private Bank Cumulative Returns basis PB ratio being below and above the mean

In fact, whenever NIFTY private banks have traded below the mean for the past 15 years, it has done well for the next ~1Y (Almost double the average return for the same duration in the overall period) and has underperformed significantly when it has been above the mean.

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Current Scenario

Exhibit C: NIFTY Private Banks P/B 2008-2023

Currently, NIFTY Private Bank is trading at 2.57x, which is below the 15Y average P/b of 2.93x, implying undervaluation and given the past patterns, setting up for a good year ahead.

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Conclusion

Well, just like always, this is one data point, there are multiple factors when it comes to banking and not just the valuations, inc. credit cycles, the asset quality, and more.

But seeing that it has had a good correlation in the past in predicting the return, its perhaps isn’t that bad an idea to look into this sector.

Disclosure: personally, I’m exposed to them to about 4% of my portfolio through 2 stocks, so as always, consider my views, biased.

Until next time, keep manifesting wealth.

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Disclaimer 1: All above views are purely for educational purposes and are not to be taken as investment advice. Investment or trades taken of any kind based on this are solely the person’s risk and I bear no liability. Please consult a financial advisor before making any investments. All investments are subject to market risks.

Disclaimer 2: The views presented above are mine and not of any organization(s) I work with / am employed at

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Sources:

• NIFTY Indices