Big bank profits aren't enough

They may be high – but profit alone isn't enough for investors

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As consumers, the banking system is unavoidable. Sure, you don't have to deal with one of the big four – there's always Bendigo and Adelaide Bank Limited (ASX: BEN), Suncorp Group Limited (ASX: SUN), or Bank of Queensland Limited (ASX: BOQ), and a (shrinking) number of credit unions.

The fact remains, however, that the bulk of both consumer and business banking is done with one of the majors – Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corporation (ASX: WBC) and National Australia Bank Ltd (ASX: NAB).

If you bank with any of the so-called 'four pillars', today's article in the Australian Financial Review – reporting JP Morgan's forecast of $12.5 billion in combined profit – might raise the blood pressure a few notches. It's a lot of money.

Perhaps not as much as you think

That profit, if achieved, equates to around $550 for every man, woman and child in Australia, using this morning's 'population clock' numbers from the Australian Bureau of Statistics.

Of course, the banks make a large proportion of their profits from business banking, insurance, wealth management and some other areas, so they're not literally making $550 from each of us each year.

Perhaps I've been conditioned to expect bumper profits, but I was surprised the 'per head' profit was as low as it was – I was instinctively expecting something in the $1000+ bracket.

Profits aren't all bad…

Large numbers make great headlines. They are manna from heaven for bank-bashing politicians. But as I argued recently:

"It has become fashionable to take a swing at our banks, given their billions of dollars in profit and planned staff cuts. I think the criticism is largely unfair – on a purely pragmatic basis I'd rather have a profitable, lower risk banking system rather than the risk-laden, growth-at-any-cost culture that developed in the United States and Europe in the first 7 or 8 years of this century.

If the cost of a stable economy (and remember, our unemployment rate still has a 5 in front of the decimal point, compared to the US at 8.3 per cent and the Euro area at 10.4 per cent) is a couple of extra dollars in bank profits, that's not an unreasonable price to pay, even if it does stick in the craw."

… but not enough

Turning to investors for a minute – after all, our purpose is to Help Australians invest. Better – large numbers aren't enough. There are two reasons.

First, the economist's favourite analogy: the pie. You've heard this before, but it bears repeating. The question for investors shouldn't be 'how big is the pie', but 'how many pieces are there'. There's no point having the world's largest Four 'N Twenty pie – from the good people at Patties Foods Limited (ASX: PFL) – if you have to share it with 100 other people. Far better to have a pie that's half as big, but share it with one or two others (or keep it to yourself)!

The second element is the growth in that pie. We all know that inflation takes a bite out of our savings each year, so not growing means your purchasing power is going backwards. Even keeping up with inflation isn't good enough – a term deposit will soundly beat the CPI at the moment.

Foolish take-away

I'm not going to get into the argument of how much is too much profit from our banking sector – that's an argument for another day.

Investors need to see a reasonable level of growth in excess of inflation to help offset the risk of investing in equities. While the banks are offering some nice dividend yields at the moment, even they'll be eaten away by inflation if they don't continue to grow.

The return on equities has averaged 10 – 11% over the last century or so. For bank shareholders, high profits and a nice dividend is a good starting point, but it won't be enough if growth doesn't follow.

If you're looking for income from your shares, look no further than "Secure Your Future with 3 Rock-Solid Dividend Stocks". In this free report, we've put together our best ideas for investors who are looking for solid companies with high dividends and good growth potential. Click here now to find out the names of our three favourite income ideas. But hurry – the report is free for only a limited time.

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Scott Phillips is an investment analyst with The Motley Fool. You can follow him on Twitter @TMFGilla. The Motley Fool's purpose is to help the world invest, better. Take Stock is The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it's still available. This article contains general investment advice only (under AFSL 400691).

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