The Best Bargain Among Kenya’s Big Three Bank Stocks

KCB, Equity Group, and Co-operative Bank of Kenya have just released their mid-year financial statements.

Let’s take a look at the numbers to determine which Kenyan bank offers investors the most value now.

Start With the Book-to-Price Ratio

When analyzing a bank stock, the first thing we want to figure out is its book value per share.

Also known as net asset value (NAV) or shareholders’ equity, book value is the amount left over after subtracting a company’s liabilities from its assets.

Total Assets – Total Liabilities = Book Value

For example, Co-operative Bank has total assets of roughly Ksh398 billion and approximately Ksh330 billion worth of liabilities. Thus, its book value is roughly Ksh68 billion.

Ksh398 billion – Ksh330 billion = Ksh68 billion

We then divide this figure by the bank’s total shares outstanding to arrive at the stock’s book value per share.

Co-operative Bank has issued 5.867 billion shares. So, in theory, if the bank shut down today and settled all of its liabilities, each investor would be left with Ksh11.59 for each share that he or she owned.

Pretty neat, right?

Now let’s compare this book value per share figure to the stock’s current price.

As I write this, Co-operative Bank’s share price stands at Ksh17.05.

Wait a second… why would anyone pay Ksh17.05 for a share of a bank that will only be worth Ksh11.59 if the bank were to shutter its doors tomorrow?

Because investors are betting that the bank won’t shut down tomorrow. In fact, they not only believe the bank will remain open, but they’re betting that it will grow and thrive for many years to come. Therefore, they’re willing to pay a premium above book value to reap the rewards of this growth.

The book-to-price (B/P) ratio measures the magnitude of this premium. To calculate it, simply divide the company’s book value per share (Ksh11.59) by its current share price (Ksh17.05). Co-op’s B/P ratio is 0.68.

Follow the same steps for KCB and Equity Group, and we’ll find the following:

Company	Book/Price Ratio
Co-operative Bank of Kenya	0.68
Equity Group	0.46
KCB Group	0.65

All else being equal, the higher a stock’s book-to-price ratio is, the better the return it potentially offers. Why? Because you’re buying more of the company’s book value with each shilling that you invest.

Thus, Co-operative would appear to be the best of the bunch. With a book-to-price ratio of 0.68, 68% of the stock’s current price is literally in the bank.

But wait!

Not all banks are created equal. Some grow quickly. Others seem content to rest on their laurels. Some work relentlessly to innovate and improve the efficiency of their operations, while others are more lackadaisical. In other words, some banks are just more profitable than others.

Thus a bank with a high book/price ratio might turn out to be a dud of an investment if its profitability isn’t up to snuff.

Calculate the ROE

We can quickly measure a business’s profitability by looking at its return on equity (ROE).

ROE measures how much profit a company earns relative to its book value. To calculate it, we simply divide the company’s earnings during the most recent twelve-month period by its average book value during the period.

ROE = Earnings / ((Beginning Book Value + Ending Book Value) / 2)

All else equal, the higher a stock’s ROE is, the better.

The chart below shows the ROE of each of our three Kenyan banks over the most recent twelve months.

Company	Return on Equity (ROE)
Co-operative Bank of Kenya	18.0%
Equity Group	23.9%
KCB Group	21.8%

Wow. Equity Group is generating a return of nearly 24% on each shilling’s worth of book value. In light of that, it’s easy to understand why its book-to-price ratio is lower than the other two banks. It’s simply more profitable. Consequently, investors are willing to pay more for its shares.

But are they justified in doing so? Is Equity Group the NSE’s best big bank bargain?

To find out, let’s put the B/P ratio and ROE together.

Derive the Implied Return

Equity Group’s B/P ratio of 0.46 tells us that if we invest 100 shillings in the company, we are effectively buying 46 shillings worth of the bank’s book value.

If we assume that Equity’s ROE will remain level at 23.9% over the next twelve months, then the 46 shillings of book value will grow by nearly 11 shillings.

Ksh46.00 x 23.9% = Ksh10.99

Thus the return on our Ksh100.00 investment is 10.99%.

Perform the same calculation on KCB and Co-op, and we get the following implied returns over the next twelve months.

Company	Implied Return
Co-operative Bank of Kenya	12.2%
Equity Group	10.9%
KCB Group	14.2%

So, there we have it. With an implied return of 14.2% over the next twelve months, KCB offers the best combination of profitability and value.

Some Notes of Caution

In the last step of the above valuation exercise, we made a pretty significant assumption. We assumed that each bank’s ROE would remain level over the next twelve months. This will almost certainly turn out to be inaccurate.

I don’t expect the real numbers will end up being dramatically different, but if you do, substitute your ROE forecast for the one I used and see how it alters the stock’s implied return.

Finally, keep in mind that Kenyan investors can obtain a 10% return nearly risk-free by purchasing the M-Akiba Bond. Thus, an implied stock return of 11%, 12%, or even 14% isn’t terribly exciting given the risks inherent to investing in shares.

I’d like to see KCB drop to a price of Ksh47.00 before rating the stock a “buy.” At that price, the stock’s implied return would exceed 15%.

Your Turn

What do you think about this quick valuation exercise? Which one of the three banks do you believe will end up being the best performer over the next twelve months? Let’s hear your thoughts in the comments!