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6 Metrics Bank Investors Must Know – Part 2

Singapore’s banking trio of DBS Group Holdings Ltd (SGX: D05), Oversea-Chinese Banking Corp Limited (SGX: O39), and United Overseas Bank Ltd (SGX: U11) are amongst the top 10 largest companies in the stock market here by market capitalisation.

Given their size, there are two observations I have. First, it’s likely that there are many bank investors out there. Second, investors will likely come across the banks in their investing lifetime. These make the ability to analyse bank stocks important.

Unfortunately, banks can be complicated creatures. But, that doesn’t mean we have to resign to being helpless when it comes to determining how good a bank stock is. There are some simple yet crucial metrics that can give us a head-start when it comes to making sense of banks.

I’d be talking about a total of six of those metrics that bank investors have to know. The first three metrics had been covered in an earlier article. I’d be sharing about the next three in here.

4. Nonperforming Loans (NPL) ratio

The NPL ratio has a simple formula:

NPL Ratio = Nonperforming Loans / Total Loans

Banks earn their keep predominantly by making loans. Banks are also highly-leveraged entities. These traits make a bank’s ability to write good loans important. The NPL ratio measures how lenders perform in this regard.

DBS, OCBC, UOB NPL ratio

Source: Banks’ annual reports and earnings releases

As you can see, OCBC has been the most prudent of the three local banks in Singapore when it comes to making loans

5. Loan-to-deposit Ratio

Banks survive on liquidity and one measure of a bank’s liquidity is the loan-to-deposit ratio. Mathematically, it is given as:

Loan-to-deposit ratio = Total Loans / Total Deposits

The basic business of banking involves a bank taking in deposits and loaning out that capital to individuals or businesses. The loans that are made often can’t be recalled at short notice whereas depositors can ask for their deposits back in a relatively short amount of time.

If a large horde of depositors start pulling money out from a bank together, that’s when a bank may run into liquidity problems. With a high loan-to-deposit ratio, there’s less margin of safety for a bank to meet withdrawals or sudden emergencies.

DBS, OCBC, UOB loan-to-deposit ratio

Source: Banks’ annual reports and earnings releases

When it comes to the loan-to-deposit ratio, it’s UOB which has shown the highest commitment in giving itself larger room for error.

6. Book value per share

The book value of a bank is found simply by subtracting a bank’s total liabilities and minority interests from its total assets. To get the book value per share, we next divide a bank’s book value by the number of shares outstanding.

Here’s how the math works out:

Book value per share = (Total Assets – Total liabilities – Minority Interest) / Number of shares outstanding

This metric is important because it’s a good proxy for the underlying economic worth of a bank. The faster a bank’s book value per share is growing, the faster it is building value for its shareholders.

Caution, however, is warranted for banks that are growing their book values per share really quickly. That’s because banks can supercharge their growth over the short-term by ramping up risks (such as making poor loans). Investors must keep an eye out for such irresponsible actions as excessive risk-taking can easily cause a bank to blow up when the tide turns.

DBS, OCBC, UOB book value per share

Source: S&P Capital IQ

Over the period under study from 2010 to 2014, Singapore’s trio of local banks have been growing their book values per share consistently though somewhat unspectacularly. That may be a good sign for conservative investors as it shows that the banks are not taking on undue risks to drive unsustainable growth.

A Fool’s take

As noted earlier, banks are notoriously tougher companies to analyse as compared to say, a simple manufacturing firm. I hope what I’ve covered here can help give you a leg-up when you’re looking at banks.

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.