I found one Romulo‘s (member of Seeking Value group) question intriguing.
“How do you evaluate companies in a financial/Banking sector with regards to D/E ratio and ROA?”
That is indeed a tough question. Why a bank would have high debt (as assumed) while achieving less profits (as assumed) in terms of its assets?
Rather than spending time knowing at what economic cycle the Philippine banks may be at right now-
An alternative solution will be (as I personally would do) to seek companies to invest in with less than peer average of D/E (debt to equity ratio) and higher than peer average of ROA (return on assets). Usually, to be more conservative, I demand from a business that it should have <0.5 D/E ratio.
Let’s start with defining the D/E and ROA.
According to Investopedia, D/E is a financial ratio indicating the relative proportion of shareholders’ equity and debt used to finance a company’s assets. For me, the lower the better. ROA, on the other hand, is a financial ratio that shows the percentage of profit a company earns in relation to its overall resources. The higher the better.
When used as an assessment criteria or a metric, I assume it is better to compare these values among its peers.
Let’s gather some of the top Philippine banks and top United States banks.
*Since these values are ratios, no currency conversion is required.
Philippine banks included will be: BDO Unibank, Bank of the Philippine Islands, Metropolitan Bank, Security Bank, and China Bank.
U.S. banks will be: Wells Fargo, Citigroup, Toronto Dominion (Canadian), JP Morgan, and Bank of America.
Let’s dive into their numbers:
*sources used were from Barron’s and author’s calculations (data used were from 2010 to 2014).
D/E ratio (the lower, the better)
It appears that over the past five years, only BDO, BPI, and China Bank are less than the yearly group average.
The five-year group average is 0.71. Only BPI and Chinabank remain ‘conservatively’ lesser than the five-year group average.
Let’s see what’s going on in the big U.S. banks in terms of the D/E ratio metric.
Only Toronto-Dominion has have a ‘magnificently’ lower than average D/E ratio. This graph suggest for me not to do any more dissection of the DE data in this group. The five-year group D/E ratio average is 1.16-higher than the Philippines’ 0.71. The lower, the better.
Next, ROA (the higher, the better)
In the Philippines,
Over the past five years, it appears that the only outstanding bank here is the Security Bank. Chinabank was strong during the 2010-2011 period, but had underperformed the group average. Security bank appears to be an outlier in this metric too.
Let’s remove Security bank (outlier) and compare the remaining banks in terms of their average.
In this case, neither among the banks had clearly outperformed the rest. Although BDO and BPI are a bit higher than MetroBank and Chinabank.
The five-year average ROA for the Philippine banks is 1.62.
In the U.S.,
Wells Fargo (the TOO BIG TO FAIL bank) clearly ‘reigns’ supreme among the other banks in this metric.
Without Wells Fargo (outlier), Toronto-Dominion and JP Morgan had outperformed their remaining peers.
Average five-year ROA among the U.S. banks is 0.73, while its 1.62 in the Philippines. The higher, the better.
Basing on the D/E and ROA metric, I pick BPI and Security Bank from the Philippines, and Wells Fargo and Toronto-Dominion from the United States.
For further reading and assessment of these financial stocks, I suggest investors read these following two links for better understanding of what metrics to be used when evaluating financial stocks:
“You only have to do a very few things right in your life so long as you don’t do too many things wrong.” Warren Buffett
Disclosure: I am long Toronto-Dominion. I would not receive any compensation for doing this article. I am not a professional financial analyst. This is just a hobby. Lastly, my work is not error-free, but I strive for it to be. Do not consider as a buy or sell advice. Invest at your own risk.
If you are interested in this similar approach to investing and would seek updates or share your insights, I wish to invite you to this Facebook group SEEKING VALUE (https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)