Evaluating bank stocks

Ref: Motley Fool youtube. https://www.youtube.com/watch?v=AfT5FaaqNxI&list=PLXIJDn8_-fyEsbjwBto2GzIS1JPq5I2iR&index=8

Objective of banks: Borrow money at a lower interest rate and lend at a higher rate, and make profit from the spread.

3 key metrics:

1. Annual Return of Equity for 10 years. Find the lowest number. If that number is negative, bank had big losses during the 2008 financials crisis. So avoid them. Return of Equity is available in SEC 10k or q filing.

Return of Equity = Annual Income / Shareholder Equity = Annual Income / (Total Assets - Total Liabilities)

Ideally Return of Equity should be greater than 10% and for good banks it should be 15%.

The Return of Equity may be very high some months during good economic conditions if bank underwrite bad loans, which will turn bad later. That's why we need to look many years.

2. Discipline of the bank measured by Efficiency Ratio.

Efficiency Ratio = Operating Expenses / Total Revenue

Typically this ratio will be between 50-60%. If the ratio is greater than 60%, it means the financial discipline of the bank is ideal.

3. Sales Profitability

Sales Profitability => Top-line Revenue or Gross sales / Asset > 4.5%