How to Analyze Bank Stocks: The Metrics That Matter
Bank stocks require a different analytical framework than most other industries. This guide covers the key financial metrics every investor should know before buying a bank stock.
Analyzing bank stocks is different from analyzing most other companies. A retailer's business model centers on inventory and margins. A tech company's value comes from growth and network effects. Banks, however, are financial intermediaries whose core business is borrowing money at one rate and lending it at a higher rate. That means the metrics that matter are specific to banking.
Here are the most important metrics for evaluating bank stocks, in order of importance.
Return on Equity (ROE) is the starting point for any bank analysis. It measures how much profit the bank generates for each dollar of shareholder equity. A well-run large bank should consistently earn an ROE above 12-15%. JPMorgan Chase routinely earns above 15%, which is considered best-in-class. Banks that consistently earn ROE below 10% are either poorly managed, overcapitalized, or operating in a difficult environment.
Net Interest Margin (NIM) measures the spread between what a bank earns on loans and what it pays on deposits. It is the core profitability metric for the lending business. A NIM above 3% is generally healthy for a U.S. commercial bank, though this varies by business model. Tracking NIM over time reveals whether a bank is gaining or losing pricing power in its market.
Efficiency Ratio is the bank equivalent of an expense ratio. It measures operating expenses as a percentage of revenue (usually defined as net interest income plus non-interest income). A lower efficiency ratio is better. An efficiency ratio below 55% is considered good; below 50% is excellent. Banks that have been investing in technology often see improving efficiency ratios over time as fixed costs get spread over growing revenue.
CET1 Capital Ratio is the primary regulatory capital metric. It measures a bank's common equity tier 1 capital as a percentage of risk-weighted assets. The higher the CET1 ratio, the more capital buffer the bank has against losses. Regulators require minimum ratios, but investors should look for banks that maintain CET1 comfortably above their minimums, which indicates financial strength and capacity to return capital.
Non-Performing Loan (NPL) Ratio tracks the percentage of the loan book that is in default or at risk of default. A rising NPL ratio is an early warning sign of credit quality deterioration. During economic downturns, NPL ratios rise across the industry, but banks with more conservative underwriting standards typically see smaller increases.
Loan-to-Deposit Ratio compares the volume of loans outstanding to the total deposit base. A ratio above 100% means the bank is funding more loans than it has in deposits, relying on wholesale funding. Most healthy banks operate with loan-to-deposit ratios between 70% and 90%.
Book Value Per Share and Tangible Book Value Per Share (TBV) are the accounting measures of what a bank is worth on a per-share basis. Banks typically trade at a multiple to book value, with higher-quality franchises earning premium multiples. Comparing a stock's price-to-book (P/B) ratio to its historical range and peer group is a common bank stock valuation technique.
BankingTerminal surfaces all of these metrics on each bank's ticker page, including historical financial statements, bank-specific KPIs, and peer comparisons through the rankings pages. The financial highlights section on each ticker page shows ROE, ROA, NIM, and efficiency ratio at a glance.