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Why I’m avoiding the Big 4 banks at the current share prices

The big four banks are some of the most commonly owned and loved shares on the ASX. They have created strong shareholder returns, particularly when you include the juicy fully franked dividends they churn out every year.

Commonwealth Bank of Australia (ASX: CBA), Australia and New Zealand Banking Group (ASX: ANZ), Westpac Banking Corp (ASX: WBC) and National Australia Bank Ltd. (ASX: NAB) may have done well up until now, but I don’t think they are buys at the current prices for the following reasons:

Australian households are heavily in debt

A study by Digital Finance Analytics concluded that 20% of households would not be able to hang onto their homes if interest rates rose by just 0.5%.

Australian household debt to income is now at an incredible high of 189.6%, this is one of the highest ratios in the world.

The U.S. Federal Reserve is planning to steadily increase its base interest rate. The Australian big four banks will want to pass on some of this increase to everyone who has a loan, just like they have been doing already.

Banks are reporting record low bad debts

A business that is reporting low bad debts is normally a good thing. However, economies and bank performances are cyclical.

Decreasing bad debts has the effect of boosting bank profits, but in the future when bad debts increase it will hurt profits. This could easily happen because Australians are heavily in debt and vulnerable to interest rate increases, causing them to default on mortgage repayments.

High payout ratios

Banks are paying out a very high proportion of their profits, much higher than their international counterparts in Europe and North America.

Large dividends are great for shareholders in the short-term. However, it means the business has less to invest for growth, less to strengthen the balance sheet, and less wriggle room if the profit stumbles.

The big four banks’ dividends are more sustainable than Telstra Corporation Ltd’s (ASX: TLS), but are more in danger from an economic recession.

Foolish takeaway

The big four banks are strong businesses. But in my opinion it’s best to buy cyclical shares when they are near the bottom of the cycle, not the top.

If I had to choose one or two banks out of the four, I’d choose Commonwealth and Westpac. But personally, I’m waiting for a much cheaper price before being interested. If I currently owned bank shares I would sell them and invest the capital into these three great growth stocks.

A Big, Fat, Fully Franked Dividend

This company's dividend is almost the stuff of legends. Since it started paying dividends in 2007, it has increased its payout to shareholders every single year, a run that includes 21 consecutive dividend increases.

Based on the last 12-months of dividends, its shares are currently offering a fully-franked 4.8% yield, which grosses up to almost 7% when those franking credits are included. And in stark contrast to the likes of Commonwealth Bank and Telstra, this company just increased its dividend by over 13%, and guided for 2017 profits to grow by 20%!

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Motley Fool contributor Tristan Harrison has no position in any stocks mentioned. 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.

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