Is HDFC Bank Undervalued Amid Earnings Optimism and Institutional Buying?

The question of whether HDFC Bank is undervalued hinges on a delicate interplay between its valuation metrics, earnings trajectory, and institutional sentiment. As India's largest private lender, HDFC Bank has long been a bellwether for the banking sector, but recent developments-ranging from a narrowing loan-to-deposit ratio to volatile stock performance-have sparked debate about its intrinsic worth. This analysis examines the bank's valuation arbitrage potential and long-term earnings prospects, drawing on its financial performance in 2025 and early 2026.

Valuation Metrics: A Mixed Picture

HDFC Bank's price-to-earnings (P/E) ratio of 19.9x as of January 13, 2026, exceeds both its peer average of 17.2x and the Indian Banks industry average of 12.1x. This premium suggests that investors are pricing in growth expectations, albeit at a level that may not align with historical benchmarks. Meanwhile, the bank's price-to-book (P/B) ratio of 2.78x, while lower than its five-year average of 3.09x, still reflects a market willingness to pay a moderate premium for its equity. The divergence between these metrics underscores a valuation puzzle: Is the stock overvalued given its elevated P/E, or undervalued if its asset quality and deposit growth justify a higher multiple?

The absence of a clear return on equity (ROE) figure for 2025 complicates the analysis. Available data indicates a declining trend, with ROE at 10.85% for Q3 2025 and 9.97% for Q2 2025. A ROE of 14% for FY2025, while still respectable, lags behind the bank's historical performance. This decline, if sustained, could erode investor confidence and limit earnings upside. However, management's focus on reducing the loan-to-deposit ratio (LDR) below 90% by FY27-a pre-merger level-signals a strategic pivot toward operational efficiency, which may stabilize ROE over time.

Earnings Optimism: Deposit Growth and NIM Stability

HDFC Bank's earnings potential is anchored in its robust deposit growth and stable net interest margin (NIM). The bank reduced its credit deposit ratio from 110% at the time of its merger to 96% by March 2025, a move that has bolstered liquidity and reduced reliance on costly short-term borrowing. This progress, coupled with a NIM maintained within a narrow band of 3.4% to 3.5%, reflects disciplined balance sheet management. CFO Srinivasan Vaidyanathan has emphasized that the bank aims to grow deposits through expanded distribution and customer engagement rather than aggressive rate competition, a strategy that could sustain margins in a low-interest-rate environment.

Moreover, the bank's focus on retail loans- evidenced by a deposit-to-advance ratio reaching 100% in late 2025-suggests a shift toward higher-margin segments. This aligns with broader industry trends, as Indian banks increasingly prioritize retail over corporate lending. If HDFC Bank can maintain its leadership in this space while managing credit risk, its earnings could outperform peers.

Institutional Sentiment: A Tale of Two Periods

Institutional ownership changes in 2025 remain opaque, with incomplete data on quarter-end holdings. However, the bank's ADRs-a proxy for global investor sentiment- fell 6.33% on January 5, 2026, amid disappointment over its Q3 FY26 business update. This decline, coupled with a 6% drop in domestic shares over five consecutive sessions, highlights bearish technical indicators, including a breakdown from the Rs 1,000–1,020 resistance zone and weak RSI levels.

Yet, not all signals are negative. Brokerages like Axis Securities and InCred Equities remain cautiously optimistic, citing potential improvements in NIM and sustained deposit growth as catalysts for a stock rerating. The bank's recent approval of a share capital increase and bonus issue in August 2025 further underscores management's confidence in its financial health. These actions, while primarily corporate governance measures, could enhance shareholder value in the long term.

Valuation Arbitrage and Long-Term Outlook

The case for valuation arbitrage rests on the gap between HDFC Bank's current P/E and its intrinsic value. If the bank can stabilize its ROE and reduce its LDR to pre-merger levels, its P/B ratio-currently 2.78x-may rise to reflect stronger asset quality. However, the elevated P/E of 19.9x, compared to the industry's 14.37, implies that investors are already pricing in a significant portion of this potential. This raises the question: Is the stock overvalued if its earnings growth fails to meet expectations, or undervalued if its strategic initiatives succeed?

In the long term, HDFC Bank's earnings potential depends on its ability to balance growth with prudence. A reduction in LDR to below 90% by FY27 would not only align with pre-merger efficiency but also free up capital for higher-return investments. Meanwhile, its focus on retail deposits and selective borrowing could insulate it from interest rate volatility. If these strategies bear fruit, the current bearish technical indicators may prove to be a buying opportunity rather than a warning sign.

Conclusion

HDFC Bank's valuation appears to straddle the line between optimism and caution. While its P/E ratio suggests overvaluation relative to peers, its P/B ratio and strategic initiatives hint at untapped potential. The declining ROE and bearish technical indicators temper enthusiasm, but the bank's deposit growth, NIM stability, and management's confidence in operational efficiency provide a counterbalance. For investors, the key lies in monitoring the execution of its LDR reduction plan and the sustainability of its deposit-driven growth. If these factors align, HDFC Bank could yet deliver a rerating that justifies its premium valuation.