Leading Indian private banks have lagged behind global and domestic public sector peers in stock returns since December 2019. Despite robust loan growth, a contraction in valuation multiples has hampered shareholder value. This trend highlights the critical role of starting price multiples, even for banks with solid fundamental operations.
Since the end of 2019, major Indian private sector banks have seen their stock market performance trail behind both public sector counterparts and international banking peers. While the broader Sensex index posted a gain of 89% during this period, stalwarts like HDFC Bank, Kotak Mahindra Bank, and Axis Bank struggled to deliver comparable returns for shareholders. This underperformance occurred despite the banks maintaining strong business operations in India's rapidly growing economy.
Valuation Contraction vs. Business Growth
The primary factor behind this trend is a significant contraction in valuation multiples rather than a failure of core business fundamentals. Before the pandemic, these private banks were priced at high premiums, driven by expectations of sustained high growth and strong Return on Equity. However, as these growth rates normalized, the market adjusted its expectations.
For instance, HDFC Bank and Kotak Mahindra Bank saw their valuation multiples nearly halve over the last few years. Axis Bank experienced a 25% drop in its valuation multiple. Even ICICI Bank, which recorded a strong 168% share price gain, faced a minor reduction in its valuation rating. This illustrates a classic investment lesson where buying at a high price can limit future returns, even if the underlying company continues to grow its profits.
Divergent Paths in Earnings and Profitability
Individual performance within the sector has been varied. ICICI Bank emerged as a standout, achieving a 34% earnings Compound Annual Growth Rate between fiscal years 2020 and 2026 and improving its Return on Equity to 16%. In contrast, HDFC Bank and Kotak Mahindra Bank faced challenges in maintaining their profitability metrics. While HDFC Bank managed a 19% earnings growth rate during this period, Kotak Mahindra Bank saw its growth slow from 20% to 14%. Axis Bank showed a recovery in profitability, but concerns regarding unsecured lending segments have kept pressure on its stock valuation.
Impact of Foreign Institutional Ownership
Historically, these private banks benefited from significant interest from Foreign Institutional Investors, attracted by their high free float and perceived growth potential. However, the investment landscape has shifted due to rising global interest rates and geopolitical factors. Foreign ownership in these major banks has declined from December 2019 peaks. Specifically, foreign stakes in HDFC Bank, ICICI Bank, Axis Bank, and Kotak Mahindra Bank have moved to 42%, 35%, 43%, and 25% respectively. This reduction in foreign capital inflow has removed a key supporting factor that previously kept valuation multiples elevated.
Global Peer Comparison
In contrast to the Indian experience, many banks in developed markets such as the US, Japan, and the Eurozone have delivered superior stock returns. These institutions often started from low valuation bases in 2019, with price-to-book multiples around 0.8x. As these banks saw improvements in their lending businesses and earnings, they underwent significant re-rating, allowing investors to capture gains from both earnings growth and valuation expansion. For Indian investors, the focus moving forward will remain on whether these banks can sustain profitability and return on equity in a market where the previous valuation premium has largely been corrected.