The multibagger bank
HDFC bank is one of the largest private sector banks in India. In about two decades of operations its market value of equity has reached Rs.1740 b.
HDFC bank is one of the largest private sector banks in India. In about two decades of operations its market value of equity has reached Rs.1740 b.
HDFC group holds about 22.64% of shares in the bank, and about 34% is held by the foreign institutional investors. Obviously, the market price is driven by the whims of the FIIs.
One year is good:
Two years is better:
Five years is even better:
If you had bought the stock in 1998 you would have made a lot of money:
The expectations are in tact:
The fundamentals
What is it that has made the bank the market's darling? Its earnings are increasing. In 2013 it earned Rs.68,696 m compared to Rs.22,489 m in 2009, an annual growth rate of over 32%. Its book value of equity has increased at 24.83% over the period.
For any bank the key factor is the quality of book value since poor judgment in granting loans would result in erosion of equity. Furthermore, banks have loads of debt on the balance sheet because that is their capital for growth. Therefore, it is a dangerous game to consider book value growth in isolation. It is also very difficult to estimate the percentage of bad loans which can only be analyzed in hindsight.
Since the FIIs are fond of HDFC bank the assumption probably is that its non-performing assets are on the lower side, and EPS growth rate is on the higher side. That's cool.
The bank's return on equity has consistently improved from about 14.90% in 2009 to about 22.74% in 2013.
So far the fundamentals of the bank appear to be good without having a judgment on the quality of its loans, and consequently, its book equity.
The latest quarterly numbers look good too. Heck, these are neither complete, nor consolidated financials.
Value and price
I have used the last audited consolidated financial statements as of 31 March 2013 which should be alright for our purposes, although we are about a year behind. I know twelve months are too long for markets; I can't help that though.
The bank had book value of equity per of share of Rs.154 as of 31 March 2013, earnings per share of Rs.28.87, and paid out dividends per share of Rs.5.50.
We have a few options here in picking EPS and ROE as the basis for estimating value. The assumption naturally is that over time the bank will increase its dividend payout ratio, and move towards becoming a stable-growth firm.
With the current EPS and ROE as the basis, and at the current stock price of Rs.725, the markets seem to be over-optimistic about its prospects.
With EPS and ROE normalized, a more reasonable approach considering our concerns on assessing quality of book value of a bank, the markets seem to be going overboard as the market price appears to be way too high. May be I am too conservative in this approach.
Catch the markets off guard
I finally let the market tell me its expectations on the stock; and here it is:
With the normalized numbers as the starting point, the market is expecting that the EPS growth rate in the first 5 years will be about 38.05%, and gradually drifting down in the next 5 years.
With the current numbers as the starting point, the market is expecting that the EPS growth rate in the first 5 years will be about 28.91%, and gradually drifting down in the next 5 years.
Alternatively, with the expected growth rate based on the current numbers, the market is estimating cost of equity of about 3.25% in the first 5 years, and gradually moving up towards the stable growth cost of equity in the next 5 years.
Seeking happiness
Our course of action: Do some thinking on the fundamentals of the bank, its value and price, or clap along if we feel like the market is the truth.
The fundamentals
What is it that has made the bank the market's darling? Its earnings are increasing. In 2013 it earned Rs.68,696 m compared to Rs.22,489 m in 2009, an annual growth rate of over 32%. Its book value of equity has increased at 24.83% over the period.
For any bank the key factor is the quality of book value since poor judgment in granting loans would result in erosion of equity. Furthermore, banks have loads of debt on the balance sheet because that is their capital for growth. Therefore, it is a dangerous game to consider book value growth in isolation. It is also very difficult to estimate the percentage of bad loans which can only be analyzed in hindsight.
Since the FIIs are fond of HDFC bank the assumption probably is that its non-performing assets are on the lower side, and EPS growth rate is on the higher side. That's cool.
The bank's return on equity has consistently improved from about 14.90% in 2009 to about 22.74% in 2013.
So far the fundamentals of the bank appear to be good without having a judgment on the quality of its loans, and consequently, its book equity.
The latest quarterly numbers look good too. Heck, these are neither complete, nor consolidated financials.
Value and price
I have used the last audited consolidated financial statements as of 31 March 2013 which should be alright for our purposes, although we are about a year behind. I know twelve months are too long for markets; I can't help that though.
The bank had book value of equity per of share of Rs.154 as of 31 March 2013, earnings per share of Rs.28.87, and paid out dividends per share of Rs.5.50.
We have a few options here in picking EPS and ROE as the basis for estimating value. The assumption naturally is that over time the bank will increase its dividend payout ratio, and move towards becoming a stable-growth firm.
With the current EPS and ROE as the basis, and at the current stock price of Rs.725, the markets seem to be over-optimistic about its prospects.
With EPS and ROE normalized, a more reasonable approach considering our concerns on assessing quality of book value of a bank, the markets seem to be going overboard as the market price appears to be way too high. May be I am too conservative in this approach.
Catch the markets off guard
I finally let the market tell me its expectations on the stock; and here it is:
With the normalized numbers as the starting point, the market is expecting that the EPS growth rate in the first 5 years will be about 38.05%, and gradually drifting down in the next 5 years.
With the current numbers as the starting point, the market is expecting that the EPS growth rate in the first 5 years will be about 28.91%, and gradually drifting down in the next 5 years.
Alternatively, with the expected growth rate based on the current numbers, the market is estimating cost of equity of about 3.25% in the first 5 years, and gradually moving up towards the stable growth cost of equity in the next 5 years.
Seeking happiness
Our course of action: Do some thinking on the fundamentals of the bank, its value and price, or clap along if we feel like the market is the truth.
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