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Bank IPOs: An investing checklist

Oct 1, 2003

The primary market (IPO) for equities seems to be witnessing a revival of sorts with the stock markets going through a bullish phase. While this is a general behaviour that is observed in periods of bullish stock markets, we would like investors to be cautious regarding the decisions (in terms of IPOs) they take. This is because companies in order to take advantage of the positive sentiment sometimes take retail investors for a ride, and hence investors need to be extra careful regarding the same. Public sector banks, off late, have been successful in tapping the primary markets. There have been two IPOs already in 2003, with another one is scheduled in the next few days. What should retail investors consider as far as bank IPOs are concerned. While in our earlier article Check List for Investors we had addressed this topic, i.e. a checklist for retail investors in more general terms, in this article we would like to enumerate the checklist that investors need to focus on as far as Bank IPOs are concerned.

Does the retail investor easily understand the sector, its dynamics and its prospects?

Since we are discussing about the banking sector, the investor needs to first understand the sector dynamics thoroughly before making any investment decision. A detailed article on how the banking industry functions, has been carried by us. The current status as well as the prospects of the industry has to be analysed well.

Is track record of the bank important?

The performance history of the bank is a very important factor that needs to be considered when analyzing any company. The history indicates the strategies adopted by the bank, its success or failures and whether it is a laggard or a leader. The financial performance of the company indicates the effects of the decisions it has taken in the past. It also indicates the financial health of the bank. The history of the bank should also be analysed well enough to understand the position of the bank in the sector as a whole.

Further, in case of banks it is imperative that one looks in to the quality of assets (NPA levels) that the bank has in its books. This will indicate whether the bank will be able to survive in case of any sudden pullout by customers. This is because the bank is responsible towards its depositors to ensure a good quality of assets, which will essentially protect their interests.

The past should also be studied to analyse the performance of the banks and their management. Management performance and corporate governance are key factors that need to be looked in to, especially for banks, as they deal with a large quantum of retail money and hence they are more accountable to the same. Transparency and disclosure levels are other key areas that need to be looked in to. A bank that has been unable to shield the depositors’ monies, is unlikely to do justice to its shareholders funds.

How relevant is competition in case of banks?

Competition plays a key role in any sector. Competition is intense in the banking sector, which in the Indian context is highly fragmented. Competition in the banking sector determines the spreads that individual banks earn over their lending portfolios. When one analyses competition in case of this sector, the emphasis has to be on a thorough analysis of the bank’s relative standing in the sector. One needs to analyse whether the bank is a follower or a leader (as far as strategies are concerned) in the sector.

What role does management background play in the analysis?

Apart from all these factors the management standing and expertise of the bank is also an important factor that needs to be looked into. Management and its composition in relation to the promoter holding in the bank needs to be carefully looked into. The analysis of the management is important, as one may be able to assess the probability of the bank keeping to its targets, based on the management’s capabilities. The assessment of the management capabilities can be done only if one delves deeper in to the track record of the bank, and the management’s role in the same.

Where does the money go?

Investors need to know what is the stated objective of the bank as far as the IPO is concerned. Banks need to raise capital for various reasons and one of the foremost among them are for augmenting capital (for growing the quantum of business). An IPO will augment the Tier-I capital of the bank, which will help the bank to do more business.

How do you put all the above in a snapshot?

The questions above will help the investor to assess the nature of the banking industry and the bank’s position and performance relative to competition. Investors now need to look deeper in to what all this means for the stock price of the bank. The stock price or the valuation of the bank is dependent on almost all the factors that have been mentioned above. A detailed analysis of the bank’s financial performance over the years would help us compile certain key ratios relevant to the sector. These ratios when compared to that of other banks will give us an idea of the relative financial standing of the bank among its peers.

Once this is done we will be in a better position to try and arrive at a fair valuation for the bank stock. This will give us an indication of the fairness of the IPO in terms of pricing of the issue.

A lot of investors jump into the IPO bandwagon in a market bull run, hoping to make a killing when the IPO lists, even if they understand that the concerned bank may not be a worthwhile investment. The idea is that in a bull run, everything will fly, irrespective of the fundamentals. Such a strategy seems to rely on the ‘bigger fool’ theory. But one must remember, this strategy could backfire. Research is the key to successful investing, whether in a bull or a bear run.

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