Get Maximum Value out of your 

Broker’s Report

Let us leave the analysis to the experts. Let them do all the number crunching. Let them create that detailed analysis report. Then email it to you: The investor, Managing director and CEO of your stocks portfolio. What do you do with it? Are you able to turn their recommendations into a profitable purchase? Especially if faced with recommendations from more than one broker. How we derive maximum value from the Broker’s report is the subject of this article.

For my reference I will use a report on the Kenyan banking sector published by Cytonn Investments. Our scope will be limited to banking stocks although some of the concepts will also apply to stocks in other industry sectors.

A broker’s report typically has two central themes:

1. Comparison of companies in same sector using various metrics. This goes further to compare against the industry average.
2. Focus on individual companies. This ends in a share price valuation followed by a recommendation to buy, sell or hold.

When going through a banking sector report, be sure to look out for the below:

A bank typically has a dominant client group.

Retail clients : These include individuals, investment groups and small businesses. Characterized by large volumes of low value transactions, high interest rates and high processing costs

Corporate clients : These include companies and large organizations. Characterized by large value accounts that attract high interest, large volumes of high value transactions and large loan sum per client.

You need to know whether the bank’s growth in earnings is driven by corporate or retail banking. Retail banking is a game of numbers to achieve target value. Corporate banking is about acquiring high value clients who require sophisticated products. The risks faced are also different. A bank may become overly-dependent on a few corporate clients. An ideal bank has the right mix of corporate and retail clients to cushion it from risks.

Non-interest income is income earned from sources other than loans and investments. When compared to revenue, it shows how much a bank has cut dependency on interest by diversifying its operations. The bank should however not lose focus on its primary business. Examples: Mobile banking, BancAssurance (Insurance).

Cost to Income ratio is a measure of a bank’s efficiency. An increase in CIR means expenses rose faster than income. This value should be lower than or equal to the industry average. Banks employ measures like cost-cutting and restructuring to lower their CIR. A low CIR means higher profitability.

Source: Cytonn FY15 banking sector report

This is the difference between the interest paid out on deposits and interest earned relative to the amount of interest-earning deposits.

This interest margin translates into profits. A higher NIM means the bank’s operations are more profitable. The bank generated more interest income than interest expenses paid out.

This is the amount of profit earned as a percentage of average common shareholders’ equity. It measures profitability by showing how much a company generated with the money invested by shareholders.

The core business of a bank is attracting customer deposits at low interest and giving it out to the same customers as loans while charging them a higher interest. The banks need to carefully assess its loan position to avoid becoming a victim of customer loan defaults.

This is an expense the bank charges itself as a buffer against potential bad loans/debt. It covers them against the effects of a customer defaulting on a loan. A high LLP is preferred.

This is the percentage of total issued loans that are non-performing i.e.in default or close to default. It reveals the quality of the loan book and the potential risk to the bank posed by bad loans. A low NPL to total Loans ratio is preferred.

This shows the extent to which NPLs are covered by loan loss provisions. The loan loss provision is expressed as a percentage of total NPLs. It reveals the credit risk and steadiness of the lending base. A high ratio is preferred.

This is a measure of liquidity. It shows how much of the customer deposits have been issued as loans. A low LDR means that most of the deposits have not been utilized as loans. The bank is not earning enough interest income and needs to put more effort into selling loan products.

Source : SIB – Kenyan Banking Sector FY15 Earnings review

A high LDR of say 80% means the bank is very aggressive in selling loans and is earning high interest income. However, its liquidity may not cover it from unforeseen funding requirements.

An LDR of over 100% means the bank borrowed money to fund its loans, e.g. through corporate bonds or loans from other banks.

Companies that are growing provide the best returns. For a bank, we look at growth in deposits, growth in loans, growth in income and growth in Earning per share (EPS/net profit). We want a bank that reports good growth for at least three years straight.  There should be consistency in the reported figures, for instance growth in EPS should be accompanied by growth in Income, loans and deposits. This shows that their day-to-day operations grew and not some one-off asset disposal to boost reported profits.

The profit before tax (PBT) is the money the company made before the effects of tax. It’s a better indicator of the bank’s profitability.

Here we look at the number of branches. Banks expand by opening more branches to improve the customer reach. Some banks have expanded into other countries within the region. While offering an opportunity to access a larger customer base, it might hurt the lender’s earnings during the period before the regional operation becomes profitable. A bank with a good expansion strategy is always a plus.

Expansion also covers growth in alternative channels e.g. mobile, internet and agency banking. These offer convenience to the customer and are more efficient cost-wise. Banks that are slow to adopt new technologies fail to benefit.

Deposits per branch is the total deposits a bank branch collects. Given that capital and operating costs for a branch are almost constant, high deposits are the main differentiator when trying to improve a branch’s profits. Banks with fewer highly profitable branches have lower total operating costs and are more efficient.

These metrics tell you the lending power of the bank, the major factor being the value of assets. The higher the Tier, the larger the amount of assets it owns. A big asset base allows a bank to give huge loans for funding big projects without exceeding the maximum allowed. The smaller banks are limited by their small asset base. Tier 1 banks are best placed when it comes to acquisition of smaller banks.

Market capitalization reveals the market value of the bank. As an individual investor you are better off with a small to medium cap stock. It is harder for a company with a big market cap to double the value of its share.

Source: Cytonn FY15 banking sector report

The PE (Price to Earnings) ratio reveals whether a stock is overpriced or underpriced. The average for financial sector is usually 8-9. The lower the PE, the more underpriced the stock.

The PEG (PE to Growth in earnings) ratio factors in the growth rate. A PEG value equal to or less than 1 points to an underpriced stock. This occurs when the growth rate is equal to or more than the PE.

The broker’s report should provide the PEs and PEGs for the companies being analyzed and also provide the industry average.

The book value is the value at which assets are carried on a balance sheet. We divide net assets by total number of shares to obtain book value per share. If a company was liquidated today and all its assets sold and debt paid, the remaining cash is what is shared among the shareholders. This represents the book value.

Price to Book Value (PBV) compares the current market price to the book value. This tells us how much a share is overvalued. A stock trading at less than or equal to its book value is said to be undervalued. A high PBV should be justified by other factors like high growth rate

Here the Broker mentions the positive factors that are expected to improve the company’s fortunes going forward. The risks and negative factors are also discussed.

It is easier to give buy, sell or hold recommendations. However, Brokers are reluctant to give specific price valuation as it puts their reputation on the line. See below a sample valuation for a bank

Source: Cytonn FY15 banking sector report

The investor should be able to compare recommendations from different sources. He will then use his knowledge of valuation to make a buy, sell or hold decision. This might be based on PE, PEG, PBV, growth rate and other metrics that make up the story.

Source: Cytonn FY15 banking sector report

Some Brokers go further to rank the companies based on various metrics. These should help you evaluate the strengths and weaknesses of the companies you are considering investing in.

Disclaimer: The views expressed above do not represent those of any company mentioned. 

References : Cytonn FY2015 Banking Report,  SIB – Kenyan Banking Sector FY15 Earnings review, Investopedia.

Author

Robert Omondi @ KenyanTrader254