Rather than take investment advice from a teacup technical analyst, below I'll show you how to get a super-quick fundamental valuation for your National Australia Bank Ltd. (ASX: NAB) shares.
Of course, I must (and want to) warn you that no valuation — especially an easy one like this — should be relied upon in isolation.
Is the NAB share price expensive?
Here's how it works…
Step 1: Make a forecast for NAB's next full-year dividend payment. Alternatively, go to your brokers website or use a site like Bloomberg or The Wall Street Journal to find analyst forecasts. I'm going to take a worse case scenario and guess (but, mum, everyone else is doing it!) NAB's dividend falls from its current $1.98 per share to $1.90 next year.
So, dividend = $1.90. Check.
Step 2: Pick a discount rate. There is a formula behind this called the CAPM. But really, it is just finance for: 'What percentage return per year do you demand for investing in shares?' I will pick 10%, which is around the 30-year average share market return. So, the discount rate is 10%. Check.
Step 3: Ask yourself: 'How much will the dividend grow by?' In annual percentage terms for forever (remember, that's a long time). Given what I know about NAB, I reckon 3% per year sounds good. So, dividend growth = 3%.
Step 4: This is where it gets fun. Use this formula: forecast dividend payment / ( discount rate – dividend growth)
So, in our example, we have: $1.90 / (10% – 3%) = $27.14.
'What does that tell us?' I hear you ask.
This valuation is what is known as the 'Gordon Growth Model' or Dividend Discount Model (DDM). It is used by financial analysts to value shares of mature companies with a consistent and reliable dividend.
So, congratulations! You just valued NAB shares.
Is it expensive? Given the current NAB share price of $30, you may be inclined to think NAB shares are expensive. However, as you can tell, the model is pretty simple — as many are.
And if you put garbage forecasts into the model, you will get a trashcan-worthy result. And I wouldn't bet my life savings on this model — although many do.
For robustness in your valuation, you could include a comparison of the price-earnings (P/E) and price-book (P/B) ratios of NAB with Australia and New Zealand Banking Group (ASX: ANZ) and Commonwealth Bank of Australia (ASX: CBA).
And as always you should never buy a business without first understanding it. That comes through research. For example, you could read its two latest annual reports, go into a couple of bank branches, open a NAB bank account, etc.
