Top Indian private banks have underperformed global lenders and domestic PSU banks in stock returns since 2019 despite steady loan growth. This shift, driven by contracting valuation multiples and reduced foreign institutional holdings, highlights the risks of high entry valuations. Investors may track whether improved return on equity can spark a recovery.
Since the end of 2019, India's leading private sector banks have faced a difficult period in terms of stock market performance. While the broader Sensex index has delivered a strong gain of 89% during this time, shares of major lenders like HDFC Bank, Kotak Mahindra Bank, and Axis Bank have notably trailed both their global peers and even domestic public sector banks. This performance gap is particularly striking given India's status as a high-growth economy.
Valuation Contraction Over Fundamental Decline
The primary issue for these banks has not been a lack of growth, but rather a significant contraction in valuation multiples. Investors who entered these stocks at high prices in the past have seen those premiums shrink. For instance, both HDFC Bank and Kotak Mahindra Bank have seen their valuation multiples roughly halve since late 2019. Axis Bank also experienced a 25% decline in its valuation multiple. Even ICICI Bank, which posted a notable stock gain of 168% over this period, faced a marginal reduction in its valuation multiple. This suggests that even when a business maintains solid earnings, the price paid relative to its profits remains a major driver of long-term returns.
Impact of Shifting Foreign Ownership
Before the pandemic, these private banks were highly popular with foreign institutional investors, thanks to low global interest rates and high liquidity in their shares. This high foreign ownership, which once acted as a tailwind, has turned into a headwind. As global interest rates rose and foreign investors reduced their positions in Indian equities, the high free float of these banks made their stock prices more sensitive to selling pressure. This trend contrasts sharply with major banks in the US, UK, and Japan, such as JPMorgan Chase and Barclays, which started from much lower valuation bases. These international banks saw their share prices rise as their fundamentals improved, a classic example of value investing success.
Growth and Return on Equity Realities
While Indian banks previously enjoyed consistent loan growth of 15% to 20%, the post-pandemic reality has been more varied. HDFC Bank and Kotak Mahindra Bank have faced challenges in maintaining their return on equity (RoE), a key metric for how efficiently a company uses shareholder money. Axis Bank has seen a significant improvement in its earnings, but concerns regarding its unsecured loan portfolio have limited the market's enthusiasm for the stock. Conversely, ICICI Bank has managed a stronger earnings trajectory with a 34% compound annual growth rate and an improved RoE of 16% as of the latest projections.
As the valuation froth that characterized the pre-2020 period has largely disappeared, future stock performance for these lenders will likely depend on their ability to improve return ratios and manage asset quality. Investors may track upcoming quarterly results to see if these banks can demonstrate sustained improvement in their profit margins and return on equity.