Why Do I Want Bank Stocks In My Portfolio?

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Bank Stocks

I always wanted to get my hands on the 3 Singapore Banks in my portfolio ever since i started reading about investing which are:

1. United Overseas Bank Limited (U11.SI)
2. Overseas-Chinese Banking Corporation Limited (O39.SI)

3. DBS Group Holdings (D05.SI)

Bank stocks consist many of the traits Buffett use to be considered to be part of his portfolio. 

• First, banks serve an important societal need that will never go away. 
• Second, bank's business models are relatively simple to understand, a key requirement of Buffett's investing philosophy. 
• Third, for a long time, the banking sector was considered to be a cyclical sector that used to move with the crests and troughs of economic growth. But i think that if your time horizon is long enough, they are decent enough to be considered part of your long-term investment plan as it also pays consistent dividends to all the shareholders.

Here are the 4 key metrics to analyse traditional bank stocks:

1. Return on Equity (ROE)

2. Return on Assets (ROA)

3. Net Interest Margin (NIM)

4. Efficiency Ratio

Return on Equity

ROE is how much profit a company generates as a percentage of shareholders' equity. The higher the ROE, the more efficient a company is at putting the shareholder's equity to work.

Return on Equity = Net Income/Total Shareholder's Equity x 100

Generally, a ROE of at least 10% is considered pretty somewhat up there.

Return on Assets

Another profitability measure is return on assets (ROA). ROA is a percentage of the overall profit, or net income, a company makes relative to its total assets (which includes interest-earning loans, securities, cash, etc).

Return on Assets = Net Income / Total Assets x 100

A good benchmark for bank stocks is ROA of at least 1%. ROA measures how well the bank uses all of its financial resources – both debt and equity – to generate profits.

Net Interest Margin

Another key measure of a bank’s profitability is it’s net interest margin (NIM). Basically, net interest margin is the difference between the interest a bank receives and the interest a bank pays in relation to its total interest-generating assets.

Net Interest Margin = (Interest Income from Loans – Interest Expense to Depositors) / Total Interest Generating Assets x 100

NIM tends to move in tandem with interest rates. As interest rates rise, so do bank interest margins. Although recently the net interest margin have been dropping for Singapore’s bank stocks, I think this presents an opportunity for me to buy in at a lower price for the long-hold.

Generally, a bank that keeps steadily increasing its net interest margin is considered a good sign that the company is profitably managing its assets.

Banks can improve their net interest margin by increasing the number of borrowers who are willing to pay higher interest rates (loan growth) or increase the number of depositors who are willing to accept lower interest rates (deposit growth).

Efficiency Ratio

When evaluating a bank's profitability, it's important to view it in the context of how efficient a bank is at generating its revenue. A metric called efficiency ratio does just that. It is calculated by taking the bank's operating costs, known as a non-interest expense, and dividing it by the net revenue it generates.

Efficiency Ratio = Noninterest Expense / Net Revenue x 100

The best-run banks tend to keep efficiency below 60% as a lower efficiency ratio indicates a bank is skillfully able to turn resources into revenues. Additionally, more efficient banks tend to have fewer loan defaults.

Final Thoughts

Bank stocks also make great investments for income-seeking dividend investors.

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Whether or not you'd be willing to pay more for one bank over another comes down to whether you believe the bank has good earnings, good growth opportunities, and is less risky in its pursuit to grow relative to its peers. 

Keep in mind though, you ultimately get what you pay for. Some banks are cheap because they attempt to grow their loan portfolios at the expense of quality, which means default-risk increases and jeopardizes future profits.

Do your homework and consider whether a cheap bank stock is really worth a long-term investment. 

Meanwhile, somewhere in my lalaland, i'm still waiting for the 3 banks to fall into my desired price. I will pounce on them the moment i receive a notification alert on my SGX App. 

Growing older by the second waiting..

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That's all for today! Till the next post :)

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