Bank Nifty: Money attracts money: It’s show-time for lending leaders! why over here

Bank Nifty has been in the news for the past few years for not getting enough limelight. Bank Nifty has underperformed Nifty 50 since January 2020. During this, Nifty 50 gained 37 per cent and Bank Nifty rose only 18 per cent.

In one of our previous articles, we had mentioned about the bottom line of the banking sector. The banking pack is finally coming out of the woods and is up 11 per cent compared to Nifty 50’s 7.5 per cent last month. read here

In this article, we will continue our discussion on the lending space. Now that we know the sector is attractive, we will understand why we should look at the lending sector’s valuation with a different lens than the non-financial segment.

The high price to book (P/B) ratio often bothers investors. But for a lending business, a higher P/B can be beneficial. A high P/B multiplier allows the lender to raise capital at a higher valuation. Essentially, they receive more capital in exchange for less equity.

But the question that must be arising in your mind is will this not be true for the non-financial sector as well?

Lending business is capital intensive as money is the main product. Thus, they need to raise funds from time to time to meet the demand and opportunities. There are many instances where non-financial companies have raised funds while trading at high P/B. The limitation with non-financial companies is that they can only access capital according to the demand environment. The extra capital on their balance sheet will affect their return ratio. On the other hand, capital itself gives returns in the lending business.

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Therefore, we understand that a higher P/B allows lenders to raise more capital in exchange for less equity, which is reinvested in their business and generates profitability. But then what drives the high p/b?

This is no rocket science; The market pays a premium to companies that are efficiently managed and generate high return on equity (ROE). Thus, essentially a well managed and profitable lending institution will get a premium appraisal. It will use this premium valuation to raise funds cheaply and use it to generate higher profits. Higher profitability ultimately drives the book value and an increase in the book value leads to an increase in the share price. This exemplary cycle continues for good quality lenders.

The “money attracts money” is correct to the T in the lending section. This exemplary cycle will continue to widen the gap between great lenders and non-good lenders.

Technical Outlook:

Bulls have made a strong comeback and ended July on a very positive note with a gain of over 8 per cent. This is the strongest July closing in the last 10 years. July has been seasonally the second best month for the markets. The Bulls will not be disappointed at all with such a finale. Now that we have rallied so fast it is time for you to take some chips off the table as the momentum indicators on the hourly scale are in overbought territory. The short to medium term trend remains bullish and traders should look for entry opportunities near the 16,800-16,600 levels.

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Expectations of the week:

The coming week is likely to be interesting as many important events are going to happen. Markets globally will be majorly affected by the unemployment rate of the United States, which as of last published data held steady at 3.6 percent. The unemployment rate will provide some indication as to whether the US economy is indeed in recession.

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Back home, the RBI interest rate decision will be the major headliner. Whether the MPC adopts a more aggressive approach to engage in some developed markets or stays on course remains to be seen.

India’s trade deficit widened to a record $25.6 billion in June. Thus the markets will keep a close watch on the balance of trade data points that are scheduled to be published. Given these events and the current earnings season, the market may see some volatility. The Nifty 50 ended the week up 2.6 per cent at 17,158.25.

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