1st, look at PB and not PE for banking stocks, NBFCs.
2nd, PB is a function of the market’s expectation of how much ROA, growth, and credit cost the business can deliver. Sustainably or cyclically. It will assign lower/higher PB and in turn PE accordingly.
3rd Due to recent events of DEMON, and COVID market over-priced (IMO) risk of default and LGD or risk of ruin to the bank. Now that is getting corrected. Even now the valuations of less than 2x 1yr fwd PB, underestimate (IMO) the length of the good credit + growth cycle due to recency bias. Data from the 2000s suggests longer microfinance cycles if no man-made rare black swans happen.
4th Risk of political interference has significantly reduced as microfinance has been deemed a central subject rather than the state. So local politicians cannot interfere. The market is still not pricing in the recent opening up of Telangana as a market after the 2010s AP crisis. Telangana’s HC ruled that microfinance will be governed by center.
5th IMO, given the ROA, and growth profile when valuations touch 1x 1yr fwd PB, this a very good time to buy. At 2x 1yr fwd PB, these are fairly valued and good to hold. At 3x 1yr fwd PB one should think of reducing position. If any bad news comes one should sell ruthlessly. These are my working, you can build your own DCF model based on PB, BVPS, ROA, ROE and growth to come at a valuation metric.
6th money is made when there are differential expectations between what market prices, what the business delivers and what you can catch before the market prices new expectations.
These are my understanding of the sector and I can be wrong.
Disclosure: Invested in the sector.
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