If you’ve ever taken a look at the stocks listed on an African market, you likely noticed that they tend to be dominated by banks. Quite often, banks are the exchange’s largest, most liquid shares.
There’s a lot of number-crunching to be done when deciding which bank to buy. You could spend days buried in balance sheets if you cared to.
It’s for this reason that I spend considerable time coming up with quick and easy ways to evaluate the relative attractiveness of bank stocks.
The method I walk through here scores banks in five key areas: profitability, growth, asset quality, value, and dividend yield.
Please note that this method is only the first stage of analysis. It’s intended to separate the contenders from the pretenders – not to provide me with a buy decision.
With that said, let’s put it to work on 12 of the Nigerian Stock Exchange’s biggest banks. Let the showdown begin!
If you’re in the market for a bank stock, chances are you’d prefer one that actually makes money. So, I took the liberty of screening out all the banks that failed to produce a positive average return on assets (ROA) over the past five years.
ROA measures how effectively management deploys the assets under its control. I’ve calculated ROA as after-tax profits from continuing operations divided by average assets. Then, because bank earnings can be inconsistent, I averaged the ROA from the most recent five fiscal years.
To calculate a score, I divided the range between the most profitable bank and the least profitable one into deciles. The banks with ROAs in the highest decile were awarded 10 points. Those in the lowest decile scored just one point.
Here’s how they stacked up:
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Profitability is great, but Africa’s best banks are constantly growing their assets. They’re tapping new market segments, expanding into new territory, or acquiring smaller competitors. And because the banking industry is particularly conducive to building economies of scale, a larger asset base generally translates into greater profitability.
To measure which banks are growing the fastest, I simply annualized the growth of each bank’s total assets over the most recent five fiscal years.
Here’s what I found:
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3. Asset Quality
A bank’s challenge is to lend as much money as possible for the best return possible. In their zeal to do so, some banks end up lending valuable assets to some rather uncreditworthy customers. When these customers default, the loans must be written down to zero – a bad thing for profitability AND growth.
One of my favorite ways to measure a bank’s asset quality is to determine how much of the loan portfolio isn’t performing as planned. I do this by dividing non-performing loans by total loans. A lower ratio implies a lower degree of risk in the bank’s loan book.
Look here to see which banks are Nigeria’s most conservative lenders:
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Investing, of course, is all about value. The most profitable, fastest growing, well-managed bank in Nigeria can end up losing you money if the price you pay for it is too dear.
When evaluating bank stocks, I take a close look at price/book ratios. Book value is simply the difference between a bank’s assets and its liabilities. Stocks with low price/book ratios generally have less downside risk. The lower a price/book ratio gets, the less risk there is of the bank disappointing the market and the greater potential there is for it to outperform expectations.
I prefer the price/book ratio over the price/earnings ratio for bank stocks. Why? Because bank earnings can be erratic. Thus, the P/E ratio for a bank coming off a particularly good or bad year will be skewed. Assets, on the other hand, are much less volatile and relatively easy for an accountant to value.
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5. Dividend Yield
Dividend yield is a function of both profitability and value. Generous dividends also suggest a confident management team. Dividend cuts typically wreak havoc on a stock’s share price. Therefore, most banks won’t raise dividends beyond a level they believe they can sustain.
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Winner, Winner, Chicken Dinner!
Now let’s put all the above scores together. Perhaps unsurprisingly, blue-chips like GTBank and Stanbic IBTC posted good profitability, growth, and asset quality scores, but lagged far behind when comparing value and dividend yield.
Meanwhile, high-yielding, low-priced stocks like Diamond Bank and Fidelity Bank performed poorly in terms of profitability and asset quality.
Two banks, Access and Sterling, performed well enough on all five scales to post the highest scores. In fact, they tied with a composite score of 37!
But after all this hoopla, a draw would be anticlimactic, wouldn’t it? So, I decided to give the tiebreaker to the largest bank in terms of total assets. Why? Larger banks are generally less risky than smaller ones.
As of the end of 2011, Access Bank’s asset base totaled NGN1,634 billion (roughly $10.4 billion). Sterling Bank’s total assets are NGN504.4 billion (approximately $3.2 billion).
So we have a winner of my first ever Nigerian Bank Stock Showdown! Congratulations to Access Bank (ACCESS.NL)!
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What Do You Think?
Did the results surprise you? Are there other criteria you would add to the Showdown? Would you change the weights to some indicators? Is my method madness? Let me know your thoughts in the comments!
[Disclosure: I have no position in any stock mentioned in this article, and I have no intention of taking any within the next 72 hours.]