the k-banks story

Kotak bank announced results yesterday, and Karnataka bank did so a few days back. Post results, the Kotak bank stock closed down from Rs.1398.55 to Rs.1347.40 per share; and the Karnataka bank stock closed down from Rs.124.10 to Rs.114.50. A more than 7% fall for the smaller bank and less than 4% for the bigger one. Was it justified?

On 16 July 2018, Kotak bank had hit a high of Rs.1417 from its yearly low of Rs.962; that's a phenomenal performance for the investors. In comparison, Karnataka bank hit a low of Rs.105.10 on 28 June 2018 from its high of Rs.171.60 less than a year ago. 

In terms of financial performance, management, and growth prospects, Kotak bank is way superior. But what about the future returns for the investors? For Rs.2,133 b advances, a 1.95% of bad assets is exceptional. After considering non-performing assets, the book value for Kotak bank stands at Rs.264.86 per share. At the current price of Rs.1347.40, it is trading at more than 5 times the book value. This itself should put investors on caution. Remember, the higher the buy price, the lower the potential return. This applies to all businesses including the high quality ones. Let us assume that it will grow by 15% annually in the next 3 years. Even at the exit book multiple of 4, the investment returns would be less than 6.25% including dividends. At 20% growth, the returns would be just short of 11%; wait, when you reduce the exit book multiple to 3.50, the returns fall to about 6%. 

The Karnataka bank story is un poco diferente. With non-performing assets of almost 5% on Rs.477 b advances, much lower return on assets and equity, much higher debt-to-equity, and much lower regulatory capital, the bank is of course inferior in terms of business quality. Yet, the stock is available for less than its book value, adjusted for bad assets, per share. With a 5% growth, and an exit book multiple of 1, the stock returns should be over 12% in 2 years. A little better growth, and you are off to something. Do you want to take it?

Do you see the game now, how it is diced? Take your growth expectations, take your exit multiples, and play along; a la la la la long.