HDFC, Axis and Kotak Bank vs global banks: The valuation boomerang investors missed

India, as the fastest growing major economy, has had the weakest performing large private banks. Large private lenders — HDFC Bank, Kotak Mahindra Bank and Axis Bank — have not only lost the race to PSU peers in terms of shareholder returns, but also to their global peers. These banks rank near the bottom in a comparison of returns delivered by some of the world’s largest lenders since December 31, 2019 (the pre-pandemic cut-off). In contrast, the Sensex has gained 89 per cent over the same period.

Looking back, these lacklustre returns appear to stem more from a valuation problem than to do with fundamentals. Among the banks compared, only the Indian lenders have seen valuation multiples contract. Even ICICI Bank’s 168 per cent gain is not an exception, having undergone a marginal derating. HDFC Bank’s and Kotak Mahindra Bank’s valuation multiples have halved, while Axis Bank’s have fallen by 25 per cent.

The analysis underscores the importance of entry multiples even if the underlying business continues to perform well.

Before the pandemic, the said banks were showing mid-teens to 20 per cent loan growth (FY17-20 CAGR) — far higher than the single-digit growth rates of global banks (readers should see this in the context of the growth rates of their underlying advanced economies). Their stocks were seen as prized possessions by investors.

On top of these, low global interest rates and high free float made the stocks favoured bets for FIIs in the pre-Covid era. Given India’s expanding financial services market, investors expected these banks to sustain both strong growth and high return on equity (RoE) — a critical banking metric. Their December 2019 valuations reflected these expectations (see Table).

However, since the pandemic, despite solid loan growth, HDFC and Kotak have failed to sustain RoE. HDFC’s earnings have grown at a CAGR of 19 per cent in FY20-26 (includes benefit from the merger), while Kotak’s earnings growth rate has fallen from 20 per cent to 14 per cent. Axis Bank’s profits have improved to a CAGR of 56 per cent in FY20-26 from -22 per cent in FY17-20 but concerns over its unsecured loans in recent years have weighed on its valuation. ICICI Bank, on the other hand, has reported higher earnings CAGR at 34 per cent (FY20-26) relative to peers while more importantly, its RoE doubled to 16 per cent. Their high free float has now become a headwind. With global interest rates on the rise and AI trade heating up, FIIs have offloaded a chunk of their stake. FII holding in HDFC, ICICI, Axis and Kotak have come off peaks (since December 2019) of 52, 38, 53 and 45 per cent to 42, 35, 43 and 25 per cent now.

The picture is markedly different among largest banks in each of the developed markets (the American, the British, Eurozone and Japanese banks considered for this analysis). Low entry valuations, combined with improving RoE, have translated into superior stock returns. Excluding JPMorgan Chase, the average price-to-book multiple of the foreign banks stood at just 0.8x as of December 2019, reflecting investor pessimism.

Post-pandemic, however, growth has improved meaningfully. JPMorgan Chase, Barclays, Deutsche Bank, UBS Group and MUFG have all reported stronger growth in loans, earnings and book value, leading to higher RoE. The two Japanese banks and Deutsche Bank top the return rankings, benefiting from both the lowest starting valuations and the sharpest rerating.

Other banks have also improved across one or more key metrics. Santander’s loan growth remained muted, but its earnings CAGR rose from about 2 per cent in CY16-19 to 14 per cent in CY19-25. BNP Paribas’ earnings CAGR improved from 2 per cent to 7 per cent.

Bottomline, the market has rewarded shareholders of those banks with multiple expansion, whose fundamentals have changed for the better, irrespective of the scale of the improvement, when bought at beaten down valuations — a testament to the potential of value investing. Conversely, when...