Börse Express – How to Analyze Bank Stocks

Banking stocks may seem complicated to analyze, but the reality is that banking is easier to understand than you might think. Banks are similar enough that once you’ve learned how to analyze one, you’re ready to analyze the rest.

While the business dynamics of any given bank are obviously more complex than we can explain in a sentence or two, banks essentially borrow money at a certain rate and then lend it at a higher rate, pocketing the spread between the two rates.

When trying to analyze a particular bank stock, it’s a good idea to focus on four key things:

• What the bank actually does
• Your price
• Your earning power
• The risk it takes to achieve that profitability

So let’s take a look at each of these points and how you can incorporate them into your research.

What the bank actually does

First of all, there are three main types of banks:

• Commercial banks: Those who make their living mainly from lending to customers and benefiting from their interest margin.
• Investment banks: Those who advise clients on mergers and acquisitions (M&A), facilitate stock and bond issues, manage wealth for high net worth clients and businesses, and more.
• Universalbanken: The ones that do a combination of both.

There are three things you need to look at to get a feel for what a bank is doing – its assets and liabilities (which you can find on the balance sheet) and its income statement.

financial assets

In banking, assets matter – the loans, the stocks, etc. These are the things that will determine future returns, if carefully selected, and they are the things that will make (or out of) a bank failure Cleared away) if there are problems.

So the first step is to take a look at a bank’s balance sheet.

Loans are at the heart of a traditional bank. The higher the percentage of loans in a bank’s assets, the closer it is to a traditional savings and credit bank. For example, a quick look at the balance sheet shows US Bancorp As of Q3 2020, total assets were $ 540.5 billion and loans were $ 307 billion, which means 57% of the bank’s assets are loans. That makes sense since US Bancorp is much more focused on traditional consumer business than many of its big banking counterparts.

On the other hand, there are banks that are more focused on investment banking. In the balance sheet of Goldman Sachs (NASDAQ: NASA) from the same period, we can see that only 9.9% of the assets are loans.

If a bank does not hold loans, it is most likely holding securities. There are many possible reasons for this. For example, her business model might not be lending, she might lose the lending business to other banks, or she might just be conservative if she can’t find favorable loan terms. Either way, looking at loans as a percentage of wealth gives you questions that you can research.

The next step in considering loans is what types of loans a bank provides. Is she primarily a mortgage lender? A Small Business Lender? Does she have a lot of car loans? Or, it mainly focuses on credit card loans like Capital One Financial (WKN: 893413)? You should be able to find this information on the bank’s balance sheet or in its most recent quarterly report.

liabilities

In banking language, liabilities generally refer to the deposits that clients (like you and me) make in bank accounts.

Deposits are great for banks for the same reason that you complain about low interest rates on your checking and savings accounts. These deposit accounts are basically where you lend the bank cheap money. If a bank can’t attract a lot of deposits, it will have to borrow (or issue stocks), which is usually much more expensive. That can lead to risky credit behavior – that is, chasing returns to justify the cost.

Deposits can be further divided into interest-bearing and non-interest-bearing deposits. If a bank can attract a large amount of non-interest-bearing deposits (e.g. checking accounts), this can be a major cost advantage over other banks.

An important metric is the ratio of deposits to liabilities. If a bank’s deposits make up a high percentage of total liabilities, that’s a good sign that the bank has plenty of access to cheap capital. Conversely, if there are more liabilities in the form of debt, this could indicate an unfavorable cost structure and more risk. For example, US Bancorp’s deposits make up 85% of liabilities – a very healthy capital structure.

income

There are two main categories of bank income – interest income and noninterest income. Interest income is self explanatory, but non-interest income can take several forms. Banks collect mortgage lending fees, deposit account service fees, investment banking fees, payment processing fees, and more.

Banks report their net interest income, which is the difference between the interest they collect and the interest they pay on deposits. The interest-free income is everything else. The banks usually break this down in the profit and loss account. This is a great way to get a feel for how a bank makes money.

There is no right or wrong mix of interest and non-interest income. This is just an important step in understanding how a particular bank’s business works.

The price

The obvious goal in buying bank stocks (or any other stock) is to buy them for less than their real value. But that’s much easier said than done, otherwise we’d all be rich!

When it comes to banks, we need to know two important metrics: book value and book value material book value.

If you’re not familiar with book value, that’s just another word for equity. When a bank is trading at book value, it means that you are buying it at a price equal to its equity (i.e. its assets minus its liabilities).

To get a little more conservative than the price-to-book ratio, we can look at the price-to-non-cash ratio. As the name suggests, this ratio goes a step further and leaves a bank’s intangible assets such as B. the company value, left out. A bank paying too much to buy another bank would add a pile of goodwill to its assets – and increase its equity. By refusing to recognize that goodwill, we are more conservative about what we consider a real asset. Therefore, the price / non-cash book value ratio will always be at least as high as the KBV.

However, you can’t tell whether a bank stock is cheap or expensive just by looking at its book value. If you could, it would be so easy to just invest in the bank stocks with the lowest P / B’s. As with any business, the reason you’re willing to pay more for one bank than another is because you believe their earning power is greater, more growth-oriented, and less risky.

The earning power

The key figure that bridges the gap between book value and earning power is called return on equity (ROE). In other words, the return on equity shows you how well a bank’s equity is converted into profits. In general, a return on equity greater than 10% is considered good and higher is better. And higher ROE numbers can warrant a higher rating.

If you want to take a closer look at earning power, you can look at net interest margin and efficiency.

The net interest margin measures how profitably a bank makes investments. You take the interest a bank makes on its loans and securities, subtract the interest it pays on deposits and debts, and divide that by the value of those loans and securities. Higher is better.

While the net interest margin gives you a sense of how well a bank is doing on interest rates, the efficiency rate, as the name suggests, gives you a sense of how efficiently the bank is doing its business.

The efficiency rate sets the non-interest-related expenses (salaries, building costs, technology, etc.) in relation to the income. So the lower the better. Imagine that the efficiency rate is how much the bank spends to generate its income. An efficiency rate of 60% means that a bank spends $ 0.60 for every $ 1.00 of revenue. So of course you want this metric to be as low as possible.

The amount of risk it takes to achieve that profitability

Like most other businesses, banks can potentially make more money by taking more risk.

There are a lot of metrics out there that try to measure how risky a bank’s balance sheet is. But one of the simplest and most effective is the ratio of assets to equity. And you can find both numbers on a bank’s balance sheet. A general rule of thumb for a bank is to look for a ratio that is 10 or less.

When we go deeper into valuing assets, we need to look at the quality of the credit. Let’s focus on two key figures:

• Proportion of non-performing loans (non-performing loans / total loans)
• Bad Loan Cover (Bad Loan Allowance / Bad Loans)

Bad loans are loans that are behind schedule with their payments for a certain amount of time (90 days is usually the threshold). These are bad for obvious reasons.

As with most of these metrics, what counts as a reasonable percentage of bad loans depends on the economic environment. But this percentage can give you a sense of how risky a bank’s loan portfolio is compared to other banks.

The bottom line

We left out a lot of metrics and concepts, but you’ve still been bombarded with a lot of valuable information that can help you find the best bank stocks to invest in. It’s easy to get lost in the depths of analyzing a bank, but if you create a system like the one discussed above, you can see the big picture.

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