Nifty Bank's valuation still lags Nifty 50's despite recent rally

Banks have outperformed the broader market in the past six months and most of the leading lenders have given positive returns to investors compared to a negative return delivered by benchmark indices.  

The Nifty Bank that tracks the market capitalisation of the country’s 12 biggest public and private sector banks, is up 4.6 per cent since the end of September 2024, against a 5.7 per cent decline in the Nifty 50 index during the period. The benchmark had peaked on September 30 last year on a month-end basis. Despite this outperformance, Nifty Bank continues to trade at a deep discount to the benchmark index and, in fact, the valuation gap has widened in recent weeks. 

Nifty Bank is currently trading at a price-to-book value (P/BV) of around 2.16, nearly 39 per cent discount to Nifty 50 current P/BV ratio of 3.5. The discount is down marginally from a high of 44 per cent at the end of January this year but is close to the lowest in the last 15 years. Similarly, the banking index is currently trading at a trailing price-to-earnings multiple (P/E multiple) of 14.3x, 36 per cent lower than Nifty 50 current trailing P/E multiple of 22.4x, according to Bloomberg data. The discount is down from a recent high of 42x at the end of January this year but it’s amongst the lowest in the last 18 years. 

According to analysts, the valuation discount is largely due to poor show by banks in the previous five years. “The banking index actually underperformed the benchmark index during 2021-24, and quite a few banks hardly gave any returns to investors during the period despite a rally in the broader market. This made banking stocks steadily cheaper than the overall market,” said Dhananjay Sinha, co-head research and equity strategy at Systematix Institutional Equity.   

The Nifty Bank index was up 41 per cent during September 2021 to September 2024, compared to 47 per cent rise in the Nifty 50 during the period. Banks underperformed despite reporting faster earnings growth. The Nifty Bank underlying earnings per share (EPS) was up 135 per cent during September 2021 to September 2024, far ahead of the 77 per cent rise in the underlying EPS of Nifty 50 index. Indices’ underlying EPS tracks the changes in the combined net profit of member companies on a trailing 12- month basis. Banks have continued to outpace the rest of corporate India in terms of earnings growth. Nifty Bank underlying EPS is up 12.2 per cent compared to 1.6 per cent growth in Nifty 50 underlying EPS since April last year. 

According to Sinha, the recent outperformance of banking stocks is due to value buying by investors who booked profits in richly valued sectors such as FMCG and IT Services. Banking stocks have also benefited from investors’ belief that the sector is relatively immune to the adverse impact of US President Donald Trump’s trade wars. 

The discounted valuation of banking stocks, however, suggests that many investors remain sceptical about the lenders’ ability to deliver faster earnings growth in an environment of slowing consumer demand in the domestic sector and growth challenges in India’s external sector. 

Analysts see weak earnings for banks due to slowdown in loan growth and a decline in net interest margins (NIM). “Overall system growth for banks has been softer. This with sustained liquidity challenges and strained deposit growth will feed into sticky funding cost and continued NIM pressure,” wrote Prakhar Agarwal of Elara Capital in his earnings preview of banks for the fourth quarter of the financial year 2024-25 (Q4FY25).

 

A likely slowdown in banks’ earnings in FY26 raises the risk of a reversal in Bank Nifty outperformance on the bourses.