Is 2021 the year to buy shares of National Australia Bank Ltd?
On the Australian stock market, National Australia Bank Ltd (ASX: NAB) stocks are among the most traded, along with other bank stocks like Westpac banking company (ASX: WBC) and ANZ Banking Group (ASX: ANZ). The NAB share price is currently trading around $ 28.63.
ASX Bank shares make up around a third of the Australian stock market, as measured by market cap and the All Ordinaries Index.
In the financial sector, ASX bank stocks are by far the most popular. We’re going to go over the absolute basics of valuing a bank stock like National Australia Bank Ltd. If you are truly interested in knowing more about how to value a bank stock, you should consider watch this tutorial from the Rask Australia analyst team.
Invert the PE ratio for valuations
The PE ratio compares a company’s stock price (P) to its annual earnings per share (E) (note: “profit” is another word for profit).
There are three easy ways to quickly use the PE ratio. First of all, you can use “gut feeling” and say “if it’s low I’ll buy stocks” or “if it’s above 40x I’ll sell stocks” (which is fine for you. ).
Second, you can compare the PE ratio of a stock like NAB with ANZ or the industry average. Is it higher or lower? Does it deserve to be more expensive or less expensive? Third, you can take the earnings / earnings per share of the company you are valuing and multiply that number by any multiple of PE that you think is appropriate. For example, if a company’s earnings per share (E) were $ 5 and you think the stock is “worth at least 10 times its profit,” it would have a valuation, in your opinion, of $ 5 x 10. = $ 50 per share.
If we take NAB’s stock price today ($ 28.63), along with its fiscal 2020 earnings (or earnings) per share data ($ 0.805), we can calculate the PE ratio of the company at 35.6x. This compares to the average banking sector PE of 23x.
Next, take the earnings per share (EPS) ($ 0.805) and multiply it by the average PE ratio of the NAB (Banking) industry. This translates to an “sector adjusted” PE valuation of $ 18.49.
The first valuation tool of the brokerage firm: the dividend model
A dividend discount model or “DDM” is a more robust way to assess companies in the banking industry.
DDM valuation models are among the oldest suitable valuation models used by analysts or professional brokers on Wall Street (note: just because they are old does not mean they are “good”). A DDM model takes the most recent full year dividends (e.g. from the last 12 months or LTM), or the expected dividends for next year, then assumes dividends remain constant or increase for the forecast period.
To make this DDM easy to understand, we’ll assume that last year’s dividend payment ($ 0.60) increases at a constant rate going forward at a fixed annual rate.
Then we choose the “risk” rate or the expected rate of return. This is the rate at which we discount future dividend payments in today’s dollars. The higher the “risk” rate, the lower the valuation of the share price.
We have used an average rate for dividend growth and a risk rate of between 6% and 11%.
This simple DDM valuation of NAB shares is $ 11.44. However, using an “adjusted” dividend payment of $ 1.23 per share, the valuation drops to $ 22.05. The expected dividend valuation compares to the National Australia Bank Ltd share price of $ 28.63. Since the company’s dividends are fully franked, you can choose to make an additional adjustment and valuation on the basis of a “gross” dividend payment. That is, cash dividends plus postage credits (available to eligible shareholders). Using the expected gross dividend payout ($ 1.76), our assessment of the calculation of the NAB share price at $ 31.50.
You might consider using these models as a starting point in your process of analyzing and evaluating a bank stock like NAB. However, keep in mind that these are only tools used by analysts and that in reality a good analyst and investor will likely do well over 100 hours of qualitative research before diving into their spreadsheet and to start modeling.
For example, we spend a lot of time reviewing and writing about bank stocks, but if we were thinking about investing in a bank today, we would want to get a handle on its growth strategy, economic indicators like unemployment, and then study the house prices and consumer confidence.