Ratios To Assess Before Investing In A Bank

The stock market consists of stocks from a myriad of industries from Fast loving consumer goods (FMCG), to manufacturing, to agriculture and so on. One of such sectors is the banking sector.

The stock market consists of stocks from a myriad of industries from Fast loving consumer goods (FMCG), to manufacturing, to agriculture and so on. One of such sectors is the banking sector. The Nigerian stock market consists of stocks from the retail banking sector and there are a number of them cutting across different classes usually classified as Tier 1 for the banks with the strongest fundamentals in the game to the Tier 3 banks that are not so strong as compared to the others. The strength of these banks are typically defined by their ratios – one bank in comparison with the other.

Before investing in banks, it is important to assess your investment objectives first. For example, if your objective is to preserve your capital and grow steadily, you would want to invest in banks that are stable. In other words, your focus will be on banks that have been there for decades, can maintain a profitability for a period of time, and banks that possibly pay dividends annually. To carry out fundamental analysis, here are some simple ratios you need to assess:

Return On Equity

With any investment you make, one of the first things to assess is profitability for you as an investor and this is what the return on equity does for you. The ROE ratio doesn’t just measure how much profit the company is making but it does so in relation to equity. To calculate, note that shareholder’s equity is computed by calculating all assets and subtracting all liabilities. The reason this ratio is particularly important for banks is that bank assets is generally made up of loans given out to customers so it is important to know exactly how much profit to expect per naira of equity in the company.

Net Interest Margin

If you have gone through a bank’s financial statement, you will know that the way their numbers are disclosed are a little different from how it is disclosed in other regular companies. One of such line items is how the revenue is disclosed. As opposed to ‘revenue’, what you will find is ‘net interest income’ and this is because banks make their money primarily through interest gotten from lending to their customers or through their own investments. To calculate Net Interest Margin, simply add all the interest and investment returns and subtract related expenses. Finally, divide by the average total earning assets of the bank.

Loan-to-Equity Ratio

Since banks typically thrive on loans, it is important that you understand the extent to which the bank you want to invest in is leveraged. Sometimes, banks give out loans and these monies are lost and reclassified as non-performing loans. Particularly during economic downtimes, it is better to invest in banks with lower loan to equity or loan to asset ratios. This is because these companies do not rely so much on loans and derive their monies from their investments and other noninterest-earning sources. Loan to equity is simply the total number of loans the bank has divided by the total number of equity or assets.

For ease of comparison, use the Yochaa App to find already computed ratios of companies in the Nigerian Stock Exchange. 

Written by Lawretta Egba