What are bank stocks? Why should small investors understand this investment tool

Taiwan stocks have recently been fluctuating in a high-range zone. Although tech stocks are showing strong gains, have you noticed that funds are gradually shifting toward another overlooked sector—banking stocks? Instead of putting your money into fixed deposits earning 2% annually, it’s worth understanding why bank stocks can provide stable dividends of 5-7%, and even have room for share price appreciation. This article helps you uncover the true nature of bank stocks and clarifies their role within the entire financial system.

Understanding the True Nature of Bank Stocks

Bank stocks are shares issued by banks themselves, representing your ownership in a portion of the bank. Unlike other financial institutions, banks mainly engage in deposit-taking and lending—these are the most traditional and core financial services.

In Taiwan, listed bank stocks include Chang Hwa Bank (2801), Taichung Bank, and other pure banking institutions. Their business models are relatively simple—accept deposits, issue loans, and earn interest rate spreads. Because of their straightforward operations, bank stocks tend to be more stable, unlike insurance or securities firms which can be more volatile.

Simply put, when you buy bank stocks, you’re investing in a stable “interest-earning machine.” Banks attract low-interest deposits and lend at higher rates to businesses and individuals, earning the interest spread. The larger the spread, the more profitable the bank; the narrower the spread, the less profit it makes.

Bank Stocks vs. Financial Holding Companies, What’s the Difference?

When it comes to financial investments, many people confuse bank stocks with financial holding companies. Although both belong to the financial sector, their roles are entirely different.

Financial holding companies are diversified. They own subsidiaries in banking, life insurance, securities, asset management, etc. For example, Fubon Financial (2881) not only has banking operations but also income from Fubon Life Insurance and investment fees. Due to diversified business lines, financial holding companies have stronger risk resistance and more stable dividend sources.

Bank stocks, on the other hand, focus solely on banking operations. Chang Hwa Bank (2801) is a typical example—its main income comes from interest rate spreads and service fees. Their focus makes their operations transparent, but growth potential is limited, and they are more sensitive to economic changes.

From an investment perspective, financial holding companies are suitable for those seeking stable dividends because of their diversified income streams. Bank stocks are better suited for investors who prefer “simple holding,” as their business models are clear and easy to evaluate.

Why Are Bank Stocks Worth Paying Attention to Now?

Valuations Are Entering Reasonable Ranges

In recent years, global stock markets have been dominated by electronics and AI concepts, with tech stocks often trading at P/E ratios of 25-30 times or higher. In contrast, bank stocks typically trade at P/E ratios of 10-15 times, meaning they are severely undervalued from a valuation standpoint.

As the economy gradually stabilizes, savvy investors are shifting funds toward value stocks with stable profits, reasonable valuations, and attractive dividends. Bank stocks meet these criteria perfectly.

Improving Interest Rate Environment Boosts Bank Profitability

Although the global trend is toward rate cuts, Taiwan’s financial sector continues to perform strongly. In recent years, Taiwanese financial holding companies have hit new profit records, indicating that even in a low-interest environment, banks still have ample profit-making capacity to support dividends.

The key is that banks’ interest income comes not only from the interest spread but also from loan service fees and investment income. When the economy remains stable, lending demand from businesses and individuals persists, ensuring bank profits.

Clear Capital Flows and Sector Rotation

The market is undergoing sector rotation. After a rally in electronics stocks, hot money is shifting toward more defensive financial stocks. Fubon Financial, Cathay Financial, and other financial holding companies have recently performed well, drawing attention to bank stocks.

This is a typical “attack when advancing, defend when retreating” scenario—when the economy is growing, bank stocks rise with interest rates and economic growth; during downturns, banks tend to fall less because of their strong capital buffers and strict regulations. The 2022 bear market is a good example: the Taiwan Weighted Index fell over 20%, but the financial index declined less than 15%.

Investment Advantages of Bank Stocks

1. Clear Business Logic, Easy to Evaluate

Bank stocks are unlike tech stocks filled with uncertainties. Their business models have been used for hundreds of years—simple and transparent. You only need to look at three indicators: net interest income (main profit), non-performing loan ratio (risk indicator), and capital adequacy ratio (safety margin). These data are publicly available and easy to compare.

2. Stable Dividends, Suitable for Income Seekers

Regulatory requirements compel banks to distribute most of their profits to shareholders. This results in dividend yields of around 5-7%, far higher than fixed deposits. More importantly, such dividends are difficult to be significantly cut because banks’ interest income remains relatively stable.

3. Low Volatility, Less Psychological Stress

Compared to tech stocks that can drop 10% with a pullback, bank stocks usually only fluctuate 3-5%. This low volatility is a boon for long-term investors—you won’t lose sleep over short-term swings.

4. Invisible Government Safety Net

The financial industry is closely tied to the health of the global economy. Governments are unlikely to let major banks fail easily. During the 2008 financial crisis, governments worldwide stepped in to rescue banks. This invisible safety net adds an extra layer of security to bank stocks.

Three Key Indicators for Selecting Bank Stocks

If you decide to invest in bank stocks, don’t just look at the share price. Evaluate from these three angles:

Indicator 1: P/E Ratio (Is valuation reasonable?)

A fair P/E ratio for bank stocks is around 10-15 times. Over 15 times warrants caution, as it may already reflect future growth expectations. Chang Hwa Bank (2801), with a historical P/E of 10-12 times, is considered reasonably valued.

Indicator 2: Growth in Net Interest Income (Is main income stable?)

Pay attention to the bank’s annual growth rate of net interest income. If it grows over 10% annually, it indicates good growth potential under current interest rate conditions. E.Sun Bank (2884) has shown steady growth in net interest income, making it a good example.

Indicator 3: Capital Adequacy and Non-Performing Loan Ratio (Is safety margin sufficient?)

Higher capital adequacy ratios are better—generally above 12%. Lower non-performing loan ratios are preferable; high ratios indicate poor loan quality. Chang Hwa Bank maintains high capital adequacy and low non-performing loans, making it more resilient during economic downturns.

Risks and How to Mitigate Them

Systemic Market Risks

Financial stocks tend to fall more sharply during black swan events. For example, during China’s stock market crash in 2015, the Taiwan 50 Index (0050) dropped 24%, but Yuanta Financial (0055) fell 36%. When a financial crisis hits, banks are often the first to be affected.

Mitigation: Don’t allocate all your funds to financial stocks; diversify across sectors.

Interest Rate Fluctuation Risks

Bank profits are directly affected by interest rate changes. Sudden rate hikes or cuts by the central bank can cause rapid shifts in net interest income and stock prices. It’s difficult to predict interest rate movements accurately.

Mitigation: Keep an eye on central bank policies and react proactively to interest rate environment changes.

Loan Default Risks

This is the most direct risk for banks. If companies cannot repay loans or economic downturns lead to higher personal loan defaults, banks face bad debts. Rising non-performing loans can significantly reduce profits.

Mitigation: Regularly monitor banks’ non-performing loan ratios; consider reducing holdings if ratios exceed reasonable levels.

Economic Recession Risks

Bank growth is highly correlated with the economic cycle. During recessions, demand for loans from businesses and individuals declines, pressuring interest income. Although banks are more resilient than other sectors, prolonged downturns still impact profits.

Mitigation: Track economic indicators (GDP growth, unemployment rate) and prepare contingency plans.

Comparing Taiwan Bank Stocks and U.S. Financial Stocks

If you’re considering international investments, understand the differences between Taiwan bank stocks and U.S. financial stocks.

Taiwan bank stocks: Stable dividends (5-7%), low volatility, low P/E ratios, suitable for income-focused investors; but growth potential is limited by Taiwan’s economic growth.

U.S. financial stocks (e.g., JPMorgan Chase, Bank of America): Lower dividend yields (around 3-4%), but higher growth potential, greater market liquidity, and diversified operations. The U.S. economy’s large scale and financial sector diversity offer more opportunities.

Taiwan bank stocks are better for conservative investors seeking stability, while U.S. financial stocks suit those willing to accept volatility for higher growth. A balanced approach can optimize risk and return.

Bank Stocks Are Not Suitable for Fixed Deposits; Swing Trading Is Smarter

Many buy bank stocks intending to hold and collect dividends like fixed deposits. While this is feasible, bank stocks are cyclical and not perfect substitutes for fixed deposits.

Bank stocks are classic “cyclical stocks” with strong seasonality. They are more suitable for swing trading rather than long-term buy-and-hold.

Swing Trading Strategy: Enter when the market is high and electronics stocks have rallied, as funds rotate into banks. Or buy when dividend yields reach 6-7%. Hold for several months to a year, aiming for capital gains plus dividends, then sell.

This approach allows you to earn both dividend income and capital appreciation, offering better returns than just fixed deposits.

Practical Steps:

1. Select banks with P/E below 12 and dividend yield above 5.5%
2. Use technical analysis (support/resistance, moving averages) to identify entry points
3. Buy in tranches, not all at once
4. Set target prices based on 1-2 years’ growth expectations; consider reducing holdings when targets are hit
5. Focus on dividends and fundamentals during holding; avoid over-trading

The Long-Term Value of Bank Stocks

Although they lack the explosive growth of tech stocks, bank stocks remain vital in global markets. In the S&P 500, financials (including banks, insurance, brokers) account for about 13%, reflecting their importance to institutional investors.

Over the past 30 years, bank earnings have grown faster than the overall economy, enabling them to pay dividends above average. This stable dividend-paying ability is the core value of bank stocks.

The key is understanding that the investment goal of bank stocks is not short-term doubling, but steady cash flow over the long term. If you’re comfortable with 3-5% annual capital growth plus 5-7% dividends, bank stocks should be part of your portfolio.

The advantage of bank stocks is their defensive nature—participating in growth during good times and protecting capital with dividends and resilience during downturns. This “attack when advancing, defend when retreating” trait becomes increasingly valuable in volatile markets.

Investing in bank stocks isn’t about getting rich overnight but about earning steady profits and surviving market fluctuations.