Bank valuations slump despite stronger corporate earnings growth

The Bank Nifty continues to trade at a steep discount to the benchmark Nifty 50 index, hinting at investors’ pessimism about the banking sector’s growth and earnings momentum.

 

Bank Nifty is currently trading at a 43.5 per cent discount to the Nifty 50, close to the widest gap since index valuation data first became available in 2015. The Bank Nifty is trading at a price-to-book (P/B) ratio of 1.83, compared to 3.25 for the Nifty 50.

 

The valuation discount of banking stocks relative to the broader market has widened despite the sector remaining one of the key drivers of corporate earnings in the country in recent years.

 

For instance, over the past 12 months, the underlying earnings per share (EPS) of the Bank Nifty has grown by 4 per cent, rising from ₹3,810 at the end of May last year to ₹3,960 on Monday. In the same period, the underlying trailing EPS of Nifty 50 companies grew by 4.3 per cent, from ₹1,109 to ₹1,156.5.

 

The banking sector has outperformed the broader market in terms of earnings growth over three-year, five-year and 10-year periods. Over the last five years, the Bank Nifty’s trailing EPS has risen 172 per cent, compared to 117 per cent increase in the Nifty 50’s EPS. The index EPS reflects the combined trailing 12-month earnings of companies that are part of the index.

 

Analysts attribute the disconnect between banks’ earnings growth and their valuations to a lack of investor confidence in the sustainability of the sector’s current earnings momentum. “There is a general consensus in the market that bank will find it tough to maintain their earnings momentum going forward,” said Dhananjay Sinha, co-head research and equity strategy at Systematix Institutional Equity.

 

“This is given the headwinds such as rising bond yields, rupee depreciation, growing delinquencies in retail credit, and a lack of gains from reduction in non-performing assets. In contrast, investors are analysts are more bullish about earnings growth in sectors such as automobiles, capital goods, and defence,” Sinha said. 

 

According to him, this has led to a valuation de-rating of banking stocks, even as valuations in the broader market have remained resilient or expanded sharply in some of the most-favoured sectors.

 

For comparison, the Nifty 50’s price-to-book ratio has remained largely unchanged over the last decade, moving from 3.18 at the end of October 2015 to 3.24 on Wednesday. In the same period, the Bank Nifty’s P/B ratio has contracted by nearly a quarter, from 2.4 to 1.83.

 

Similarly, the Nifty 50’s trailing price-to-earnings (P/E) multiple has declined just 4.5 per cent over the last decade, from 21.4x at the end of October 2015 to 20.45x on Wednesday. In contrast, the Bank Nifty’s trailing P/E multiple has fallen 23 per cent, from 17.53x to 13.52x during the same period.

 

This indicates a significant rise in the valuation multiples of non-banking sectors in recent years, even as banks continue to account for the largest share of the benchmark index, with a 27.6 per cent weight in the Nifty 50 as of Wednesday. It also implies that valuations in the broader market, excluding banks, are much higher than what the benchmark indices indicate.

 

Some analysts see an investment opportunity in the banking sector’s subdued valuations.

 

“Most banks now have record low bad loans and credit growth continues to grow by 10-11 per cent. This is a good investment opportunity for long-term investors,” said G Chokkalingam, founder & chief executive officer of Equinomics Research & Advisory.

 

The Bank Nifty has kept pace with the broader market and has recently started to outperform at the margins. Over the past one year, the Bank Nifty has declined 4 per cent, compared to a 4.4 per cent fall in the Nifty 50. Year-to-date, the banking index is down 10.1 per cent, versus an 9.5 per cent decline in the Nifty 50.