It Is All About ROE

Malaysian banks have recently announced their latest financials for the quarter. It is important to consider the impact of return on equity (“ROE”) on the valuation multiple (e.g price-to-book) of listed Malaysian banks.

What do we see?

ROE is generally on a downward trend for the Malaysian banking sector

IndividualBanksROE2015.png

IndividualBanksROE2015 2.png

Why is ROE declining?

If compared to matured markets, Asian banks (e.g Malaysian banks) are involved for a large part in economies that have shown good growth, higher margins and new opportunities brought about by advancing demographics. This should continue over the medium term but pressures from increasing competition, capital requirements and growing cost base will mean it is difficult to maintain the same growth. As banks are becoming more capital intensive, it would be increasingly tougher for Malaysian banks to sustain the current high returns future ROE.

European banks have been reporting single-digit ROE over the last few years.

ROE & Valuation

There is a statistical relationship between the price-t0-book (“PBR”) valuation multiple of banks against its ROE:

PBR vs ROE_ Banks

As shown above, with a relatively higher ROE, Public Bank is trading at a premium to its banking peers whilst Affin is trading at the lowest PBR due to its low ROE.

The above statistical relationship is defined as follows:

PBR (x) = 11.2089*FY15 Roe + -0.026807, r-squared of 0.767 and p-value of 0.0019597

Based on the defined formula, the predicted value may be derived for each listed Malaysian bank and be compared to its current share price:

Banks vs ROE table.png

From the above analysis (including a sensitised ROE scenario), it appears that only RHB Capital is trading lower than its predicted value of RM6.87 (base) and RM5.81 (sensitised).

Key Implications

This is a simple desktop statistical analysis. This shall not substitute the need for a detailed fundamental analysis for each of the banking stocks. Nevertheless, the defined formula based on the use of ROE enables us to form a broad range of predicted values for the banking stocks.

DISCLAIMER: THIS SITE IS FOR INFORMATION AND ILLUSTRATIVE PURPOSES ONLY AND DOES NOT PURPORT TO SHOW ACTUAL RESULTS. IT IS NOT, AND SHOULD NOT BE REGARDED AS INVESTMENT ADVICE OR AS A RECOMMENDATION REGARDING ANY PARTICULAR SECURITY OR COURSE OF ACTION. SOURCES USED IN THIS SITE HAVE NOT BEEN INDEPENDENTLY VERIFIED FOR ACCURACY. YOU SHOULD SEEK INDEPENDENT AND PROFESSIONAL INVESTMENT ADVICE IN REGARD TO YOUR INVESTMENT DECISIONS.

Author: Ken Utau

Markets Observer + Food Lover

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