Australia's largest banks have crumbled in price since they peaked in March and April this year, and investors and analysts alike (particularly those looking for yield) are beginning to see greater value in their shares.
Of the big four banks, Commonwealth Bank of Australia (ASX: CBA) could attract the most interest for a number of reasons. To begin with, it is the nation's largest bank with a market value of $137 billion while it also generated superior returns for investors in recent years when compared to any of its local peers.
Before you buy shares in the bank however, here are 10 things you need to be aware of…
- Crashing prices. Commonwealth Bank's shares hit an all-time high of $96.69 in March this year before tumbling to a low of $79.19 recently, avoiding an official 'bear market' by just 1.8%. They have since risen to $84.11.
- Bear market. The only bank that endured a heavier fall than Commonwealth Bank between March and June was Westpac Banking Corp (ASX: WBC), which tumbled more than 21%. That is, Westpac did not avoid official bear market territory.
- Mortgage market. Commonwealth Bank commands the biggest position in Australia's home loan market with 25.4% as at 30 June 2014. That is one of the key reasons why the bank has performed so strongly compared to its peers in recent years (thanks to the nation's booming property market).
- Impairment charges. Low interest rates have seen the banks' impairment charges fall to a record low (i.e. loan impairment expense as a percentage of average gross loans and acceptances has fallen from 0.62% in 2009 to just 0.15% in 2014).
While this has helped the banks to achieve record profits in recent years, investors need to be aware of the cyclical nature of bad debts. That is, they will soon begin to rise which will have a negative impact on future earnings potential. - Cyclical nature. Cyclical stocks can generate great returns for investors, provided that they are purchased near the bottom of their cycle. The banks have been a boon for investors in recent years, but now is the wrong time of the cycle to buy.
- Current valuation. At its current price, Commonwealth Bank shares trade on a ratio of 15.1x forecast earnings for the 2015 financial year, and a price/book ratio of 2.8x.
- Historical valuation. The bank's 10-year average for those measures is 13.1x and 2.3x respectively, highlighting that it is not a cheap prospect despite its recent price falls.
- Competition. Each of the banks are competing aggressively for new customers in this record low interest rate environment which is, in turn, impacting their net interest margins (that is, the profit they make on writing new loans). Commonwealth Bank's net interest margin is steadily declining, and could continue to do so in the coming periods.
- Earnings. With tougher competition, higher impairment charges and a decline in the rate of loan growth, Commonwealth Bank could struggle to grow its earnings at any significant rate over the coming years. Notably, this could also impact its ability to continue growing dividends.
- Dividends. Investors have targeted Commonwealth Bank for its generous fully franked dividend yield. In 2012, the stock traded on a dividend yield of roughly 6.75% but as the stock has climbed in price, its yield has fallen to just 5%. Given how expensive the shares are, a 5% dividend yield mightn't be enough to offset any capital losses incurred from holding the stock.
As highlighted above, some analysts are suggesting the Big Four banks are back in the 'buy' zone thanks to their recent plunge and believe they could generate reasonable shareholder returns from their current prices.
Indeed, on a historical basis, many of the banks are currently trading at a more attractive valuation, with my colleague Mike King conceding that Australia and New Zealand Banking Group (ASX: ANZ) could well be the pick of the bunch, in large part due to its international exposure.
However, what investors also need to consider are the strong headwinds facing the banking sector, and the Australian economy as a whole, which could seriously threaten their ability to maintain earnings growth and dividend growth. From today's levels, I still don't like the banks as long-term investment opportunities and believe 'Foolish' investors would be wise to focus their attention elsewhere, for now at least.
