Banks: The bull and the bear
By Scott Phillips (TMFGilla) - April 19, 2012
Australia’s banks are, along with Woolworths, Telstra and IAG, among some of the most widely held stocks in the country. The list isn’t really that surprising – our big banks have been among the most successful businesses of the last couple of decades.
What’s not to like – we’ve had huge house price growth during that time, driven partly by the increasing hours being worked by both men and women and our seemingly insatiable appetite for more and more debt.
If that wasn’t enough, negative gearing has made residential property a popular investment (driving up prices) and successive governments (both state and federal) took turns at throwing money at first-home buyers. Of course, even an elementary understanding of supply and demand will convince you that such grants just led to higher home prices – not helping first-home owners at all – but governments didn’t seem to care.
Throw in some opportunistic consolidation (CBA’s purchase of BankWest comes to mind), and the disappearance of the non-bank lenders who relied on wholesale funding from international markets, and it’s been a charmed life for our banks.
History is clear… and past
The historian has a wonderful story to tell – and if you could go back to 1980 and place your bets, you’d be reading this from a superyacht in Greece (okay, maybe a poor geographic choice, but you get the idea).
Once we finish imagining what might have been, we need to turn our attention to the future. It becomes incumbent on bank shareholders – for the sake of their portfolios – to confront a simple question with a complex and uncertain answer – is the future going to be the same as the past?
Perhaps the more accurate question is ‘do bank stocks present an attractive investment opportunity at today’s prices’? Make no mistake; inaction can be harmful to your wealth – as investors in many former ASX high-fliers (BlueScope (ASX: BSL)springs to mind) have discovered the hard way.
The case for banks
Our Big 4 banks – National Australia Bank (ASX: NAB), Commonwealth Bank (ASX: CBA), ANZ (ASX: ANZ) and Westpac (ASX: WBC) have a lock on the Australian banking market – they have overwhelmingly dominant market shares, and an apathetic customer base who complain about fees and interest rates, but are – by and large – reluctant to switch.
Tight credit standards and prudential regulation (and maybe more than a dose of luck) helped our banks escape the fate of Lehman Brothers and its ilk, with only investment bank Babcock & Brown disappearing in the face of the GFC.
If anything, the major banks have come out the other side with a less risky residential loan book, given the speed with which Australians are paying down debt.
For investors, some very healthy yields – between 6.2% and 7.2% trailing, fully-franked – also make the banks hard to go past – especially those looking for income from their share portfolios.
The case against
On the other hand, the growth of the last 30 years is unlikely to continue. Yale professor Robert Shiller (speaking of US house prices) recently highlighted that house price growth has historically not diverted from GDP growth significantly and for long – suggesting that the recent years of growth might be the exception and not the rule.
It makes instinctive sense –house prices can’t grow faster than income growth forever, otherwise repayments as a proportion of income will continue to grow – and there’d be nothing left for food, clothing and all of the other costs of life. That slowing of credit growth must therefore impact our banks.
Secondly, our banks have grown through acquisition and market share gains. With many of the regional banks now part of the Big Four, and with only small amounts of market share still to be mopped up, individual banks will struggle to grow much faster than the (now slower) average.
Compounding the slowing of house price growth and fewer opportunities to grab market share is the continued deleveraging of the Australian household and corporate sectors. From spending more than we earned, we’ve taken a huge dose of medicine. As Stockland (ASX: SGP) CEO Matthew Quinn recently said “the dinner party conversation has gone from how big my house is to how small my mortgage is”.
Lower mortgages mean both less price growth in housing, and lower mortgage balances – bad news if your business model is dependent on a growing loan book.
Weighing the evidence
That’s the banking bull and bear case – so where does that leave us?
Short of successful overseas expansion – which ANZ is attempting in Asia, and which most of our banks have been burnt trying in the past – there’s simply no conceivable way our banking sector can consistently grow at the same rates as they have in the past, short of another bout of ‘irrational exuberance’ from home buyers.
We’re seemingly stuck with lower growth. The good news is that the current prices have largely factored that in – price/earnings ratios are between 9.8 and 11.2 times trailing earnings.
ANZ may yet prove me wrong, if it can achieve what its brethren have been unable to – and grow in Asia. In the meantime, it’s hard to escape the view that for the foreseeable future, an investment in the banking sector has become largely a low-growth income play.
That might seem to make sense given the yields on offer – but the lack of growth will count against investors with a longer time horizon – yield is great, but inflation will erode even the strongest dividends, unless they’re growing.
If you must buy into the big banks, my pick is Commonwealth – it’s not the cheapest, but it is the most conservative of the bunch, and the least likely to be susceptible to unforeseen trouble. Otherwise, there are better options elsewhere.
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Scott Phillips is an investment analyst with The Motley Fool. Scott owns shares in Telstra and Westfield Group. You can follow him on Twitter @TMFGilla. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691).
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Australia?s banks are, along with Woolworths, Telstra and IAG, among some of the most widely held stocks in the country. The list isn?t really that surprising ? our big banks have been among the most successful businesses of the last couple of decades.
What?s not to like ? we?ve had huge house price growth during that time, driven partly by the increasing hours being worked by both men and women and our seemingly insatiable appetite for more and more debt.
If that wasn?t enough, negative gearing has made residential property a popular investment (driving up prices) and successive governments (both state…