How to evaluate an NBFC?
Non - banking finance firms (NBFCs) are an integral part of the Indian financial system. They play an important role in complementing the banking sector by providing credit to unbanked segments of society, in particular micro, small and medium - sized enterprises ( SMEs), which form the basis of entrepreneurship and innovation. The position of NBFCs is becoming even more relevant now, especially when the government has a strong focus on promoting entrepreneurship so that India can emerge as a country of job-creators rather than a job-seeker.
The NBFC sector in India has undergone significant transformation over the last few years. The success of NBFCs can be clearly attributed to their better product lines, lower costs, wider and more effective reach, strong risk management capabilities to control and control bad debts, and a better understanding of their customer segments.
NBFCs are certainly emerging as better alternatives to conventional banks to meet the financial needs of different sectors. Nevertheless, in order to survive and grow consistently, NBFCs must focus on their core strengths while strengthening their weaknesses. They will have to be very dynamic and constantly striving to find new products and services in order to survive in this ever-competitive financial market.
Evaluating NBFCs is a distinct kind of ballgame as NBFCs are different from manufacturing companies. There is no single metric for evaluation, you need to look at the combination. Traditionally, the following metrics have been used by citizens to evaluate NBFCs.
- Return on Assets (RoA) v/s Return on Equity (RoE): RoA ratio tells you how effective the NBFC is in its activities and raising funds. The bigger the RoA, the stronger it can rely on the asset class. RoE tells you how well NBFC produces a return on the money of the owner. The higher the better it is. This can be compared to different asset classes. About 20% is considered to be really healthy.
- Price to Book (P/B): Simply put, this is the percentage of the market cap to its book value (shareholder's equity). That ratio tells you how expensive or cheap the business is priced. Lower P / B can imply that the NBFC is undervalued. This needs to be considered in accordance with RoA andRoE.
- Spread: This is the difference between the average lending rate of the NBFC and the expense of the funds. This could be higher because of its asset class or because of the management's ability to raise funds at a lower cost. The higher the operating expenses, the smaller the distribution.
- OPEX & Growth in AUM: Operating Expenses (OPEX) as a% of AUM tells you how well managed & efficient NBFC 's operations are. At the end of the day every business needs to grow for its value to appreciate. This growth rate can be compared with other companies. Anything above 15% is considered very good.
- Gross NPAs: Operating Expenses (OPEX) as a proportion of AUM shows you how well run and effective NBFC operations are. At the end of the day, any company needs to grow in order to appreciate its worth. That growth rate can be contrasted to other businesses. Anything above 15% is deemed to be very strong.