Key Parameters for Analysing Banking Stocks
KEY PARAMETERS FOR ANALYSING BANKING STOCKS
Unlike any other manufacturing or service company, a bank’s accounts are presented in a different manner (as per banking regulations). The analysis of a bank account differs significantly from any other company. The key operating and financial ratios, which one would normally evaluate before investing in company, may not hold true for a bank (like say operating margins). Cash is the raw material for a bank. The ability to grow in the long-term therefore, depends upon the capital with a bank (i.e. capital adequacy ratio).
Capital comes primarily from net worth. This is the reason why price to book value is important. As a result, price to book value is important while analyzing a banking stock rather than P/E. But deduct the net non-performing asset from net worth to get a true feel of the available capital for growth.
Let’s look at some of the key ratios that determine a bank’s performance.
Net interest margin (NIM):
For banks, interest expenses are their main costs (similar to manufacturing cost for companies) and interest income is their main revenue source. The difference between interest income and expense is known as net interest income. It is the income, which the bank earns from its core business of lending. Net interest margin is the net interest income earned by the bank on its average earning assets. These assets comprises of advances, investments, balance with the central bank and money at call.
NIM = (Interest income - Interest expenses) / Average earning assets
Operating profit margins (OPM):
Banks operating profit is calculated after deducting administrative expenses, which mainly include salary cost and network expansion cost. Operating margins are profits earned by the bank on its total interest income. For some private sector banks the ratio is negative on account of their large IT and network expansion spending.
OPM = (Net interest income - Operating expenses) / Total interest
Unlike any other manufacturing or service company, a bank’s accounts are presented in a different manner (as per banking regulations). The analysis of a bank account differs significantly from any other company. The key operating and financial ratios, which one would normally evaluate before investing in company, may not hold true for a bank (like say operating margins). Cash is the raw material for a bank. The ability to grow in the long-term therefore, depends upon the capital with a bank (i.e. capital adequacy ratio).
Capital comes primarily from net worth. This is the reason why price to book value is important. As a result, price to book value is important while analyzing a banking stock rather than P/E. But deduct the net non-performing asset from net worth to get a true feel of the available capital for growth.
Let’s look at some of the key ratios that determine a bank’s performance.
Net interest margin (NIM):
For banks, interest expenses are their main costs (similar to manufacturing cost for companies) and interest income is their main revenue source. The difference between interest income and expense is known as net interest income. It is the income, which the bank earns from its core business of lending. Net interest margin is the net interest income earned by the bank on its average earning assets. These assets comprises of advances, investments, balance with the central bank and money at call.
NIM = (Interest income - Interest expenses) / Average earning assets
Operating profit margins (OPM):
Banks operating profit is calculated after deducting administrative expenses, which mainly include salary cost and network expansion cost. Operating margins are profits earned by the bank on its total interest income. For some private sector banks the ratio is negative on account of their large IT and network expansion spending.
OPM = (Net interest income - Operating expenses) / Total interest