Earning comparison between Financials and other businesses

Q&A: Questions & Answers Investing Basics Q&A
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I am an aggressive Financials guy and holds a 90+% portfolio in Banking and finance stocks.

My Thesis:
The entire world runs on credit, our system is designed to take debt and take more and more debt and never to repay back. Even if everyone were to repay, there isn’t that much money in the system(Due to interest component). Only way the world is going to progress is by building more and more credit in the system. It’s a one-way ride- no doubt.
So, there is literally unlimited runway for financials. So, these companies will continuously make truck loads of profits for unlimited time and will contribute to big % of total country profit pool.

Now,
I have started researching Reliance industries .

  • Their Refining and petrochemicals business- Massive. Literally Massive. Their outstanding project execution in building multi Lak cr refining and manufacturing facilities. Such a unique massive scale with literally no other company having the guts to build or even imagine building or competing in their scale.

  • JIO- another massive telecom investment and such a unique asset base(Tangible-Towers,Fiber,network etc)+Retail franchise+ Digital platforms with massive loyal base.- Massive

  • Retail business, with massive 12k stores[Imagine the supply chain and project execution hurdles]+ Reach+ Customer access +Leases+inventory management+ Ability to build multi billion dollar brand through it’s network.- Masssive

Each of these businesses have 50+kcr PAT potential- Massive and unique assets.

Now, When I compare earnings from Reliance and a bank(Say HDFC Bank)

Efforts and value creation by reliance for generating 30kcr Profit is far far far massive than that of what is made by an HDFC Bank for their 30kcr PAT.

I somehow got huge respect for non-financials/Non-commoditised business entrepreneurs for their efforts in this value creation process.

Another example to feed upon:
Piramal enterprises has built a 50kcr loanbook with 3% type ROA and 1k+cr PAT. Can you imagine how many customers do they have ? less than 500. They can manage entire portfolio in a excel sheet. they don’t even need a core banking solution from nucleus or even building complex lending,monitoring & collection scorecards, no automation for bureau submissions,not CIR stuff etc etc. Nothing. You have excel sheet +equity+processes+people that’s it, you have top 10 NBFC in India.
Imagine how many non financials entrepreneurs can make such kind of profits with such comparatively less efforts? None.

Same is the case with many non bank finance companies that i see, finance is the major profit machine with less efforts in their entire group companies Bajaj Fin,Chola, Mahindra etc

I feel like Banks are creating credit and making profits, Other industries and services businesses are boosting their profits pools out of the credit generated at the expense of banks taking risk on their books.

One more example:
None of these world’s biggest banks with trillions of dollars in assets are valued at more than 500bill$

companies that make less these profits are valued at multiple times more than that.

++ Casestudy of JP morgan launching a cobranding credit card with apple. where JP morgan did all the dirty work in building the entire solution and apple simply dictating terms.

I am doubting my strategy on going with 90+% financials now, maybe soon there will be a day where all the financials trade at below book and value addition business will more and more strategic value and will trade at far far higher premiums that that of bank valuations.

or

Maybe my thought process is wrong and we will stand to get rewarded generously in financials too. Maybe Profits, Profitability, and earnings growth only matter and not how they make it.

Note: I know that financials are valued at Bookvalue, ROA stability, blackswans street(1/5,1/10,1/100s) - stable PAT is taken as a metric for better comparison in above case.

Views invited.

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@Yogesh_s @deevee @sahil_vi @lingalarahul7

Interested to understand your perspective on this.

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IMO This is a deeply risky position. Regardless of conviction and skill level, such deep concentration in any single class/sub-class of asset (Equity, sub-sector of equity, 1 AMC or 1 stock) exposes the investor to undue risk. I agree with the hypothesis that the need for banking is not going away any time soon. However, how are you sure that the specific instruments picked by you are the ones who would capture most of that growth?

IMO, the most important lens through which to evaluate a lending finance company is the asset quality vis-a-vis the NIMs. If provisions+write-offs can be managed at 25-30% of NIMs then the company can indeed continue to grow profitably for a long duration of time. But this is easier said than done. There have only been a few such examples in past 20 years in India: HDFC bank is one which comes to mind. However, it is difficult to know what would happen in the future because us retail investors do not have full visibility into the asset book of the bank: We do not know to whom they have lent the money. This is what makes the lenders risky. IMO some of this risk can be minimized by insisting that you’ll only buy the lender below or at book value, refusing to pay any premium valuations. However, this is difficult to execute over long durations of times, specially during bull markets where all stocks trade at premium valuations.

The Intellectual property for a lender is the risk management system & Sales team.

  1. Return of capital over Return on Capital. Among the 100 people that apply, how do they determine which 30-40 are most likely to return the capital back?
  2. Seeking out good borrowers through good customer relations: How can the bank consistently seek out good borrowers and attract them towards borrowing from the bank?

These are certainly not trivial matters. Banking/lending is not a commodity business IMO. Check out this video where Aditya Puri is asking a Bajaj Auto dealer why they do not tie up with HDFC bank for loan disbursal. Why they prefer tying up with Bajaj Finance.

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Any reason why financial stocks around the world dont perform? ex bank of america…wells fargo…barclays…Deutsche Bank…

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Think of banks as debt funds.That is what they inherently are (deposits to loans). Their returns are hence strongly correlated to those of the debt market returns. History shows that equity returns beat debt market returns.

So then the question is why are NBFCs any different. Why do they have better returns at least in Indian markets. While there can be a lot of debate, I believe the prime reason is that they go sub-prime! Higher risk, higher returns targeting the un-banked section of the economy.

Why would anyone want to invest in bank equity then? I for one, see them as an alternative to debt funds which is safer (especially if you stick to larger banks with good reputation)

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