SHARES

Should you buy, hold or sell the big four banks?

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The Invast team has been writing about banking valuations since May 2014 and we think it's not too late to sell the banks at these levels.

Perhaps we were a little too early to call the top in the big banks earlier this year, but we stuck to our fundamentals and maintained our view that they were sells as they hit record highs.

That's now paying off for our clients given that those big bank shares are now trading at much lower levels.

Bank shares

Our grievance with Australian banks isn't their balance sheet quality, rather the elevated earnings multiple on which they trade.

Unfortunately, the conversation around Australian banks is dominated by two camps - the bulls who dismiss the high-earnings multiple and the bears who think the world will collapse and housing market losses will wipe out the banks.

There's room for a middle argument, one that recognises our banks as among the most attractive in the world but equally overvalued, based on a combination of factors. That's why we consider them a sell.

Take ANZ, for example, where profit is actually falling. Earnings rose for the full year to September 30, 2015, but fell in the second half.

Earnings are just part of the picture when analysing a bank. The balance sheet is the most important. Banks are in the business of pricing risk - they put their balance sheet on the line in order to make profit every single year.

So how does ANZ's balance sheet look? OK, for now. The book value per share is around $16. This is what shareholders would be left with if ANZ stopped trading today, paid off its liabilities and sold its assets.

We're comfortable paying around 1.5 times book value for a stock such as ANZ - this is a 50% premium to what the business is theoretically worth. So we are adding a premium. But that still only gets us to $24 per share or thereabouts.

Surprisingly, that's where the share price looks to be heading by the end of the year. A 1.5 times price-to-book multiple would imply CBA at $48, NAB at $30 and Westpac at $25.

That's a lot lower than where CBA, Westpac and ANZ share prices are now. Only NAB sits higher.

Dividend payments are a method of capital management - whether the cash sits with the bank and shareholders have entitlement to it via shares or the cash is paid out does not really matter.

The release of franking credits is probably the main consideration, but we at Invast would never base our argument around taxation. We think tax considerations should never be primary drivers. Dividend payments have no bearing on our view.

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James Mair
November 11, 2015 11.39am

You consider the banks are a sell, and the idea that they are currently heading down seems to agree with that thinking. However, there is data that basically rejects that assessment: just a couple of years ago, CBA shares dropped to $25 yet last March they were in excess of $96, therefore it would seem that the best advice would be to sell - but why not wait until they revive, and then to sell? Sure, you can sell now and wait until they go further - but what if they don't, it's always a cycle anyway?

Dividend payments may have no bearing on your view, but a lot of retirees buy, and rely on, shares for the dividend income regardless of price. Yes, share prices fall, but they go up again and if the banks go bust then the country has gone bankrupt as well . . . regardless of how much you may have in a bank account, it's going to be worthless.

Just a thought.

Brad
November 11, 2015 9.18pm

Remember though that the government guarantees deposits of up to $250k per institution, so if there is a default you should be protected as a depositor. There is no such guarantee on share prices and although like you said, they usually go up again at some stage, it doesn't always happen in the time frame that you want - especially if you are a retired person. Likewise there is also no guarantee of future dividend payments. You should never buy shares based on dividends alone " regardless of price" as you mentioned, despite the temptation to increase your income. I think preservation of capital is more important at the moment.

James Mair
November 18, 2015 3.34pm

Hi Brad. Yes, I tend to agree, although I did say: "but a lot of retirees buy, and rely on, shares for the dividend income regardless of price," not all retirees. I did buy CBA 12 years ago because of the needed divided income. Preservation of capital, where it is certainly important, at any time of buying shares, that thought would have to have been a hindsight judgement, However, winding back the clock is not easy for retirees like myself.

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