This will not be an overly technical look at analyzing bank stocks. You could easily write a book about all the things you can analyze with banks. But it will at least give you a place to start.
First, realize that banks are very strange businesses. Loans are assets and deposits are liabilities. Sounds strange, but if you think about it, it makes sense. Second, to an extent, a bank can decide how much profit they want to make in the short run. A store cannot suddenly make a bunch of money easily. But a bank can. All they need to do is write a bunch poor quality loans. In the short run, they’ll receive payments on those loans and earnings will look great. Until it doesn’t. This behavior of writing bad loans wiped out the entire Savings and Loan industry in the early 90s.
Generally banks are not stocks you want to own to make 1000% on your money. Most of them are pretty conservatively run. At least we hope so. But for modest growth and a solid dividend, bank stocks can be pretty nice.
When analyzing banks, you first want to make sure they are on a solid financial footing. If it’s a larger bank that has issued bonds, you can see what the Moody’s and S&P bond ratings are. You want it to be investment grade (i.e. BBB3 or BBB-) at a minimum. Then look at their dividends. You can find that information on Morningstar. See what their dividend coverage is. You want the pay out ratio to be less than 50%. Also dividend growth will be an indicator that the company is growing the business relatively conservatively.
On a qualitative basis you want to look for sudden changes. Often, sudden changes are risky. A bank with 500 branches taking over a bank with 30 branches is just another day at the office. But a bank with 500 branches taking over a bank with 300 branches, deserves a hard look. If they are buying a troubled bank, they are buying a whole lot of trouble relative to their size. Also look to see if they are getting into new businesses. If they are gradually moving into equipment loans, great. However, if out of nowhere they are suddenly doing large private equity loans, that’s a warning sign.
Strong financials and incremental growth in your bank stocks can lead to solid, if not spectacular returns.