Based on its current dividends, National Australia Bank Ltd. (ASX: NAB) shares are not a buy.
Price versus value
In investing, as in life, there is a difference between price and value.
The most successful investor — according to some — is Warren Buffett.
He said, "price is what you pay, value is what you get".
Another famous investor, Philip Fisher, said, "The stock market is filled with individuals who know the price of everything, but the value of nothing."
Indeed, many of us could find the price of NAB or Commonwealth Bank of Australia (ASX: CBA) shares on the net, in an instant.
But how many of us know what they are worth?
What are NAB shares worth?
There are many different tools to calculate the value of an investment and if I were valuing NAB shares for my own portfolio I would not rely on just one of them.
Using ratios like the price-earnings ratio (P/E) or price-to-book ratio (P/B) is a quick and sometimes crude measure.
Another valuation model you can use is a dividend discount model (DDM). Specifically, the Gordon Growth Model, which uses a company's dividends to estimate its value.
Unlike some other models, the Gordon Growth Model is simple to use.
The formula is:
NAB half year dividends
NAB's yearly dividend is $1.98. That is, for the last two years it has paid two 99 cents per share dividends.
The growth rate refers to the growth in dividends. For context, NAB's dividends have increased at an average rate of 1.7% per year over the past 10 years. I'll round the growth rate to 2% per year.
The rate of return is a little more complicated, but it works out to be 10.5% using my calculations.
So, we have ($1.98 * 1.02%) / 8.5% = $23.78.
Meaning, according to the widely used Gordon Growth Model, NAB shares are worth $23.78 per share based on forecast dividend growth of 2% per year.
They currently trade at $30 per share.
Foolish Takeaway
This is just one model for valuing NAB shares. It ignores things like franking credits and sudden increases and falls in dividends over time (it assumes a 2% growth rate).
However, I think it is more realistic for valuing bank shares than many other models used by analysts.
Bottom line: It appears NAB shares are a little too expensive to buy today.
