Is National Australia Bank Ltd. ridiculously cheap?

Credit: NAB

National Australia Bank Ltd. (ASX: NAB) shares look cheap.

  NAB Peer-group average
Price-Earnings Ratio (P/E)(times) 11x 12x
Dividend Yield (%) (fully franked) 7.4% 6.8%
Price-Earnings-Growth (PEG) 1.9x 2.7x

As can seen from the table above, shares of NAB appear good value relative to its peers, which include Westpac Banking Corp (ASX: WBC), Commonwealth Bank of Australia (ASX: CBA), Australia and New Zealand Banking Group (ASX: ANZ), and smaller regional players.

Is NAB ridiculously cheap?

It’s important to consider what goes into these numbers before drawing any conclusions about NAB’s value.

NAB has a lower (better) price-earnings ratio (P/E) than its peers. However, the P/E is an unreliable indicator of value, especially for intensely cyclical businesses, such as banks.

The market or S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) currently boasts an average P/E of 16.5x.

The price-earnings growth ratio (PEG) factors in forecasts for next year’s profits. It is arguably a more reliable measure of value. Analysts prefer a lower PEG ratio to a higher PEG. With a ratio of 1.9x, NAB’s shares appear better value than its peers when we factor in earnings per share forecasts.

Finally, dividend yield is a crude measure for most shares (dividends are optional — management isn’t compelled to pay them every year), but it is arguably a robust valuation measure to benchmark established companies over a cycle. And at the end of the day, few investors would complain if NAB could only pay its enormous dividend four out of every five years. At 7.4% — fully franked — NAB’s dividend yield is a compelling feature for income-starved portfolios.

Cheap or ridiculously cheap?

Using a dividend discount model (DDM) to value NAB shares in absolute terms a value of around $28 does not appear excessive. That implies a 4% margin of safety (the difference between estimated value and market price).

In my opinion, NAB shares are not ‘ridiculously’ cheap at today’s level, just cheap relative to peers and the market. Therefore, NAB shares are not a standout buy. Investors should wait for a more compelling entry point.

NAB may have a big dividend, but I'm also looking for other - faster growing - dividend shares to add to my portfolio, like the one The Motley Fool's expert analysts hand-picked as their best dividend share idea for 2016.

Indeed, our resident dividend experts named their Top Dividend Share for 2016. Not only are the shares dirt cheap, the company is growing and trading on a 5.6% fully franked dividend yield. Simply click here to gain access to this comprehensive FREE investment report, including the name of this fast growing ASX dividend share. No credit card required!

Motley Fool Contributor Owen Raszkiewicz does not have a financial interest in any company mentioned in this article. Owen welcomes -- and encourages -- your feedback on Google+, LinkedIn or you can follow him on Twitter @ASXinvest.

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

HOT OFF THE PRESSES: My #1 Dividend Pick for 2017!

With its shares up 155% in just the last five years, this ‘under the radar’ consumer favourite is both a hot growth stock AND our expert’s #1 dividend pick for 2017. Now we’re pulling back the curtain for you... And all you have to do to discover the name, code and a full analysis is enter your email below!

Simply enter your email now to receive your copy of our brand-new FREE report, “The Motley Fool’s Top Dividend Stock for 2017.”

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our Financial Services Guide (FSG) for more information.