How To Analyze & Pick Best Nigerian Bank Stocks – Learn How I Select The Top Performing Bank Shares To Buy, Invest In Using Quarterly & Audited Financial Statements
A few weeks ago, I had a training session with some group of friends to share strategies to picking stocks to trade and when to buy. While we explored some company’s financials to validate our buy or sell ratings, I quickly opened my live account on Meritrade.com platform to reveal my current stocks and reasons I picked each of the stocks. At the end of my analysis, a friend asked, why is a major percentage of your equity portfolio exposed to the banking sector? I knew someone will ask that question because, on the pie chart presented on my dashboard, they assigned percentages to sectors accountholders have more shares in. It was my response to that question that I am sharing this 4-day article on how to analyze and pick the best performing banks’ share to trade.
This doesn’t mean that banking stocks are the best of all the listed equities, after all, investors reaped a bountiful harvest in certain stocks outside the banking sectors, look at Dangote Sugar, May & Baker, Fidson Health Care, and Cement Company of Northern Nigeria, these stocks surged more than 100% last year. But, here is a catch I see more in the banking sector that I don’t joke with – it is called liquidity. Banking stocks record most trading volume in the Nigerian stock market which means institutional investors; fund managers, investment bankers, pension funds administrators, insurance companies are more active in that sector compared to others. I had shared an experience of how I was stuck in the insurance sector for two weeks, I couldn’t sell my shares in one of the listed companies in that sector as no one bid for stocks until the price from N1.75 fell to 50k.
The second reason is that the current economic cycle driven by rising oil price will support banking stocks to the upside as asset quality is going to improve, the value of non-performing loans is already at the peak and expected to fall as firms in various sectors like consumer good, industrial goods and oil sector are also expected to generate more cash from operating activities to financing their short term and long term obligations. The positive impact on banks financials will be reflected in their interest income and as the cost of borrowing reduces, finance cost is also expected to be lower compared to the similar period when economic risk was higher.
Also, banking stocks have shown resilience in the face of a difficult operating environment. These guys know how to pass their operational cost to account holders via charges and fees. I know two banks that are good at that, you can’t withdraw more than N10,000 at a go via ATM, so if you want N100,000 to finance emergency needs, be ready to make N10,000 withdrawals multiple times at N65 per withdrawal. These e-business channels drive their non-interest income.
And lastly, Investors love dividend income, banks are one of the consistent dividend payers in the Nigerian stock market.
These are the four key premises I stood on to build more of bank’s equity portfolio, but the question again is, does that mean all the banks are good to buy? Well, Yes/No. The sentiments on banking sector right now is positive so expect both performing and non-performing banks to have a share of that wave. Early this year (2018), we saw how Tier two banks (even when there was no fundamental news) like Skye Bank surged from 50k to N1.26, Wema, Unity Bank, and FCMB stocks, hence rewarded early investors as they all doubled their portfolio value in less than 30 days. The growth is generally attributed to the expected positive impact of the rising oil price on the banking sector.
Does it mean you should start picking any banking stocks randomly? No, the simple truth is “no matter how high or low a stock is, it will definitely correct itself to reflect the true fundamentals of the company”, so don’t just rush into any banking stock because prices are on the increase, do your homework, learn how to check key figure and estimate the value.
To help you find a better path, I will be sharing my researched steps to analyze and pick the best banking stocks to buy.
The way you analyze stocks in the banking sector is totally different from other sectors. Banks don’t sell physical products so you shouldn’t expect the normal sales growth calculation, cost of sales, inventory turnover ration, etc to suffix here.
See – How to pick best-performing stocks in consumer or industrial good sectors
If Dangote Sugar is on your watch list, the way you interpret their financial statement cannot and shouldn’t be the same as Zenith or UBA.
So, follow me as I share my practical strategies to pick best performing banking stocks.
Find top gaining banks
The mistake a lot of stock traders make is that they don’t have a planned and well-organized strategy to picking the best-performing stocks, They rely on their broker or financial adviser and whatever these guys say, they do. It’s not wrong though but here is a simple guide to picking one of the best-performing banking stocks:
- Look at the banking sector’s index performance on a YTD ( year to date) and QTD (quarter to date) basis. The banking index closed the year 2017 at 73%, making it the best performing sector, so that is the first step.
- Compare all the bank stock’s performance with the overall index.
- Select the banks whose YTD, QTD, and MTD (month to date) stock price outperform the index; pick stocks that increased more than 73%.
Although you may see some bank stocks that lagged last year now ranked as the top performer this year, I still believe selecting banking stocks like this will help you focus on the best bank to invest in.
Some of the banks that emerged from my picks are GTB, Zenith, FirstBank, Access Bank, and Stanbic IBTC.
Understand the core business of these banks
Don’t just pick Zenith, UBA or GTB bank because you love the name but rather do your simple maths to understand the business of the bank. When I say “business of the bank”, I mean try to find out what the bank does and how they make money. As simple as this is, I will share a calculation that easily reveals the type of business a bank does. Never be too smart to say, I already know that banks accept deposits, pay a meager interest on savings and then give it out a loan at a higher interest, that’s all. You may be right but if you invest in that mindset, I bet you, you could miss out on the best bank to invest in right now. The reason is that it’s not all bank that is in the business of earning interest alone, some are investment driven.
Let’s use Zenith bank financial statement for the 9 months Sept 2017 to illustrate this:
As at 30th, Sept 2017, Zenith bank had a total of N5.1tr in asset out of which loan and advances were N2.1tr, that is 41%. If you look further, you will also see that the total investment in both fixed and equities is N961b (addition of N718b in treasury bills and N242b investment securities), which is 19% of the bank’s total asset.
Now, we can say that Zenith bank is a loan driven business because it has 41% of its asset in loan and advances. From this, you can also say that Zenith bank is exposed to loan risk because their major core revenue is interest income. At least, we saw how the bank’s exposure to Etisalat loan default affected its profit as its provided for non-performing loans.
On the other hand, if the bank’s asset had been exposed more to investment in securities, I would have said, it was an investment-driven bank.
How does the bank get the money?
Just as we have looked at the type of business a bank does, we also need to know how they source for the money. A bank can either get more deposit from customers or issue debt securities. Deposits are great for banks for the same reason you complain about getting low interest on your savings or fixed deposit account, banks are equally happy as you are lending them cheap money to lend out at a higher interest rate. If a bank can’t attract enough deposit, it has to issue debt securities like commercial papers or sell the equity side which is generally more expensive to finance. So, you see why banks will push their marketers to any extent in order to get that cheap deposit from you.
Using Zenith bank’s financials, let’s see how to get more money to give out as the loan by comparing their deposit to liabilities.
Zenith bank has over N3tr in custody as customers’ deposit, N4.3tr as total liabilities and that is over 75% deposit/liabilities which is quite reasonable and equally 70% customers’ deposit is advanced to customers. All these confirm to me that Zenith bank takes the deposit (cheap money) and gives out a loan with those deposits at a higher rate.
So, if I had said that banks improving margin will come from a higher interest income from reduced non-performing loan this year, Zenith bank is one stock you should watch out.
Look at the bank’s earnings figure
We have already deduced that Zenith bank is a loan driven business which means, the bank is expected to generate more profit from net interest income and compliment it with income from fees and charges, also known as noninterest income. Net interest income measures what how the bank makes money from borrowing from you at a lower rate and lend/invest at another higher rate via loans and securities.
Using the statement of profit or loss and other comprehensive income, let’s see how Zenith bank is fairing based on what they reported in 9 months Sept 2017, against 9 months Sept 2016.
Zenith bank earned N154b on net interest income down from N167b in the same 9 months period, 2016. This is attributed to more than 100% increment in the impairment charge from loan losses. Non-interest income, in the same period, grew from N94m to N169m; the bank was able to generate more money, outside interest repayment, from fees, charges from e-business channels. An increase in noninterest income (NIR) helps cushion the effect of interest rate volatility and loan risk but at times CBN regulation on fees may influence NIR; for instance, the suspension of ATM withdrawal fees a few years ago wasn’t good for banks as most of the posted a negative growth in their non-interest income.
From the statement presented, profit after tax grew by 35%, from N95b recorded in 9 months 2016 to N125b in the same period, 2017
To analyze the profit of Zenith bank, I check interest, noninterest earnings, and profit after tax, then compare with the previous quarter or fiscal year.
You see, there are many lines to look at in the financial statement of a bank, but these are the things I focus on first before doing my next check using ratios.
Metrics to analyze your bank
We have looked at the profit figures of Zenith bank and I can say that they are great but does that really mean shareholders are happy? Let’s see what the earnings power, strength, and value are:
Earnings power of your bank
Here, I always look at three things: return on equity (ROE), return on asset (ROA) and net interest margin.
The 9 month Sept 2017 ROE of Zenith bank is solid at 16.8% (N129b/N767b) against 13% report last year. ROA in the same period stood increased to 2.5% from 2% in 2016.
Breaking earnings power down further, you can look at net interest margin and efficiency.
Net interest margin measures how profitable a bank is making investments. It takes the interest a bank makes on its loans and securities, subtracts out the interest it pays on deposits and debt and divides it all over the value of those loans and securities. In general, it’s notable if a bank’s net interest margin is below 3% (not good) or above 4% (quite good). Zenith bank is at 4.95% (N154b/N3.1tr) against 5.5% in 2016. The fall, which is still among the highest in the banking sector, is not unconnected to the double-digit growth in impairment charges.
While net interest margin gives you a feel for how well a bank is doing on the interest-generating side, a bank’s efficiency ratio, as its name suggests, gives you a feel for how efficiently it’s running its operations.
The efficiency ratio takes the non-interest expenses (personnel and operating cost) and divides them into revenue. So, the lower the better. A reading below 50% is the gold standard. A reading above 70% could be cause for concern. Zenith bank’s operational efficiency improved from 36% in 9 months 2016 to 30.4% in 2017.
A bank may have unfavourable efficiency in certain quarters or financial year. This doesn’t mean they are not doing well, they could be investing in technology like banking channels or improving their customer service. Take note!
My next focus is the loan risk since banks make more money from the interest charges on loan and advances, it, therefore, means that an increase in impairment charge affects the interest earnings potentials. According to creditexplained, Loan impairment charges are basically money that is put aside by a bank in case its customers cannot make the required loan repayments, but which will leave a huge dent in a company’s profits. For Zenith bank, 2% of loan and advances were written as impairment charge compared to less than 1% provision in 9 months Sept 2016.
I always use this to check whether the bank is good at lending money to customers who aren’t going to default. No bank can achieve 100% on this but the lower, the better. Zenith bank is one of the banks with the lowest non-performing loan ratio.
Lastly, let’s look at the bank’s share value using EPS figure. Zenith bank’s EPS figure is at N4.11 compared to N3.03 in 9 months 2016. Using Warren Buffet valuation approach, I divided the figure by 10-year bond yield of 13% to arrive at an estimated stock value of N31. Zenith bank shares, as at 7th, Feb. 2018, is N32.
Now, this is just third quarter EPS, if I project a full year EPS of N5, then Zenith bank’s estimated value will be N38 (5/0.13) which is 15% above the current share price.
I started buying the shares from N22, then added more units as the price drop and reversed from a key support region.
To confirm my estimated value, take a look at GTB, the shares traded at N38 region when the bank reported an EPS of N4 in 2017. So, there is an upside potential in Zenith bank’s share.
Update: Zenith bank reported a 2017 full year EPS of N5.66 which presents an estimated value of N43.
Did you find this guide on how to analyze banking stocks interesting? please share any other banking stocks you feel will do well this year.