Can ANZ stock price outperform the S&P/ASX 200 in 2022?
Our top banking stocks represent more than a third of the local stock market, measured by the market capitalization of the 200 largest companies in the S&P/ASX 200 Index.
If you really want to understand how to value a dividend stock, such as a bank or REIT, you should consider looking at the video tutorial from Rask Australia’s analyst team.
PE ratio analysis
The “PE” ratio compares a company’s stock price (P) to its earnings per share (E) for the most recent full year. Remember that “benefits” is just another word for profit. This means that the PE ratio simply compares the stock price to the company’s most recent annual earnings. Some experts will try to tell you that “lower PE ratio is better” because it means the stock price is “low” relative to the earnings generated by the company. However, stocks are sometimes cheap for a reason!
Second, some extremely successful companies have operated for many years (a decade or more) and never reported a book profit – so the PE ratio wouldn’t have worked.
Therefore, we think it’s important to dig deeper than just looking at the PE ratio and thinking “if it’s below 10x, I’ll buy it”.
One of the easy ratio models that analysts use to evaluate a bank stock is to compare the PE ratio of the bank to the stock you are looking at with its peer group or competitors and try to determine if the stock is too high or cheap compared to the average. From there, and using the principle of mean reversion, we can multiply earnings/earnings per share by the industry average (E x sector PE) to reflect what an average company would be worth. It’s like saying, “If every other stock has the price of ‘X’, so should this one.”
If we take ANZ’s stock price today ($23.55), along with earnings (i.e., earnings) per share data for its fiscal year 2020 ($1.21) , we can calculate the PE ratio of the company at 19.5x. This compares to the banking industry average PE of 22x.
Next, take the earnings per share (EPS) ($1.21) and multiply it by the average PE ratio for the ANZ (Banking) sector. This translates to a “sector-adjusted” PE valuation of $26.51.
Why dividends matter to ANZ investors
Since ASX bank stocks like ANZ tend to pay dividends – and they are relatively stable companies like REITs or ETFs – we can use a modeling tool called the Dividend Discount Model or DDM to make an assessment .
A DDM uses the dividends shareholders are expected to receive to arrive at a valuation.
To make this DDM easier to understand, we will assume that last year’s dividend payment ($0.60) increases at a fixed rate each year.
Then we choose the “risk” rate or the expected rate of return. This is the rate at which we discount future dividend payments into today’s dollars. The higher the “risk” rate, the lower the stock price valuation.
We used a blended rate for dividend growth and a risk rate between 6% and 11%, then got the average.
This simple DDM valuation of ANZ shares is $11.44. However, using an “adjusted” dividend payment of $1.40 per share, the valuation jumps to $25.10. The expected dividend valuation compares to ANZ Banking Group’s share price of $23.55. Since the company’s dividends are fully franked, you may choose to make an additional adjustment and make the valuation on the basis of a “gross” dividend payment. That is, cash dividends plus franking credits (available to eligible shareholders). Using the expected gross dividend payment ($2.00), our assessment of the ANZ share price forecast at $35.85.
Is this ANZ valuation reasonable?
Our two templates could serve as an introductory guide to how the assessment process works. Analyzing a banking stock like ANZ Banking Group is a complicated task. If we were looking at stocks and considering an investment, we would first want to know more about the bank’s growth strategy. For example, are they looking for more loans (i.e. interest income) or more non-interest income (fees for financial advice, investment management, etc.)
Next, take a close look at economic indicators such as unemployment, house prices and consumer sentiment. Where are they going ? Finally, we believe it is important to assess the management team. For example, when we pulled culture data from ANZ, we found that it wasn’t a perfect 5/5. Culture is something to think about.