A breach of faith in Indian banks should prompt investors to do a lot more due diligence before they decide to buy these stocks, said Aswath Damodaran, professor of finance at the NYU Stern School of Business.
Investors must do their homework rather than take the numbers at face value, said Damodaran who is known for his work on valuing companies and understanding stock investments. “You can’t just buy a bank because it has high dividend yield anymore. That is extraordinarily dangerous way to invest in banks if you don’t know all the stuff that you need to.”
India’s lenders, especially the government-owned banks, are grappling with a severe bad loan problem. Gross non-performing assets of all the banks in the country amounted to Rs 8,40,958 crore in December, led by industry loans followed by services and agriculture sectors, as per the government estimates. The Reserve Bank of India is currently in the middle of cleaning up this mess with the help of the Insolvency and Bankruptcy Code.
A similar situation in the U.S. ahead of the 2008 global financial crisis prompted Damodaran to change the way he values banks. “I said in 2009 that the way I value banks has to change. The way I historically value banks which took the dividends and I assume that was earned by sensible people, so I can value them based on dividend, I can’t do it anymore because I don’t know whether they are paying what they can afford to,” he recounted.
He believes that investors don’t know the full story on India's banking sector woes yet. So valuing a stock becomes tougher. “The problem with telling a story when you don’t have all the facts is that you keep getting hit with more negative surprises.”
With the worst of the bad news out in public knowledge, the industry will go through an adjustment phase, Damodaran said.
Adjustment phases are never fun because for the bank an adjustment phase is to bring the regulatory capital up and get bank to help. The key is to make sure that all the bad news is out.Aswath Damodaran, Professor (Finance), NYU Stern School of Business
The NSE Nifty Bank Index has kept pace with the benchmark NSE Nifty 50 Index, rising over 16 percent in the last 12 months. The Nifty PSU Bank Index, however, fell 17.4 percent during the period.
Also Read: India’s Banks Need A Stronger Watchdog