Banking stocks have seen a phenomenal rally in the last few weeks, following the Union Budget 2016. State Bank of India and ICICI Bank are higher by 20-25 per cent, since hitting lows in Feb. There are a number of reasons why we have selected banking stocks.

One is that we believe that there will be a couple of more interest rate cuts coming this year. Apart from this there is a high possibility of a turn around in the economy, which means we could see NPAs falling.

Karnataka Bank

This is one of the most undervalued banking stocks. At Rs 100, the stock gives a dividend yield of almost 5 per cent. Now consider this: the company reported an EPS of Rs 23 and this year it most likely would report an EPS of Rs 20, going by the three quarterly results so far.

This means the stock is trading at a p/e of just 5 times. Where do you see a p/e of just 5 times for a private sector bank. Coming to the non performing assets of the bank, it is much better than most peers in the business.

The gross NPA at 3.56 per cent for the quarter ending Dec 31, 2015, is much better than even ICICI Bank. It is significantly better than every PSU bank in the country.

Now consider the price to book value. At just 0.56 times, the stock is undervalued. Going ahead even if the stock trades at 1 time book value, it should fetch you a price of Rs 150, which is 50 per cent from the current levels. Remember, the Karnataka Bank has hit a 52-week high of Rs 158, so it is way below that price as well.

Federal Bank

The story of Federal Bank is almost similar to Karnataka Bank, though Karnataka Bank is a much better pick, because the fundamentals like p/e, price to book and dividend yield are more favourable for Karnataka Bank.

Nonethless, Federal Bank too also has the potential to generate up to 50 per cent returns in 2-years time.

Let's take a quote from a recent management interview of Shyam Srinivasan, MD & CEO on moneycontrol.com

"So, our guidance then and now continues to be an improving portfolio and whatever was seen as stressed in corporate has been addressed. Retail and SME trending quite well and continue to do so."

If one goes by comments than looks like the worst maybe over for the bank. What this means is that we could see improved visibility in non performing assets going forward. The stock has slipped from a 52-week high of Rs 79 to the current levels of Rs 49.90. We believe that the stock can give an appreciation of 50 per cent in the next two-years.

GoodReturns.in