In this bull market, love is a rising dividend.
So when Australia & New Zealand Bank (ASX: ANZ) hiked its dividend by a better than expected 11%, no surprises that the market fell further in love with it, and the banking sector in general
The Great Dash for Fully Franked Dividends shows no signs of abating.
No matter that on just about every traditional valuation measure, the banks look overvalued. Investors are just piling on in and enjoying the party.
And who can blame them?
Interest rates are low, and set to fall even further — according to Credit Suisse, financial markets expect official interest rates to fall below 2.5% within 12 months. With that unpleasant prospect staring savers in the face, by comparison, rising fully franked dividends yields are gold.
Speaking of gold, the precious metal is now yesterday’s story. Today’s gold is fully franked dividends.
The old saying goes there’s always a bubble somewhere. The other old saying goes that bubbles almost always inflate more than you could ever rationally expect.
Writing in The Age this week, respected commentator Matthew Kidman said it’s unquestionable a share price bubble is forming in the Australian banking sector. He also said it is reasonable to expect the bubble to inflate for some time to come rather than pop soon.
Inflating we shall go…
A rational bubble
As far as bubbles go, this one is entirely rational.
Banks have been great investments. The big four dominate the market, and as such, in this benign economic environment, generate huge, dependable, reliable profits.
And with interest rates on term deposits falling, and predicted to fall even further, in an income-starved world, plonking your cash on bank shares seems an entirely rational and sensible move.
Until it’s not…
Share valuations you can bank on…until you can’t
An article in The Australian Financial Review lead with the suggestion the valuation game for banks has changed. saying “conventional methods used to value banks no longer apply.”
You could have knocked Joe Magyer, our resident banking expert, down with a withdrawal slip.
Joe knows a few things about banks, and about investing. A recent addition to our investing team, you’ll be hearing more from Joe in the weeks and months ahead.
Over to Joe…
— Qualitatively, I’ve never heard a quote like the above that didn’t end in tears.
— Commonwealth Banks’s returns on assets are only 1%. That’s extremely mediocre for a bank, let alone one of its size and seeming competitive advantages.
— Commonwealth’s loan book is running at 120% of deposits. For perspective, it’s typical for U.S. banks to do something like 100%. In this environment, though, Wells Fargo and JP Morgan can only find enough demand to do 80%. That’s all to say, the size of the loan book and, by extension, returns on equity, could suffer an incredible haircut if Australia dips into a recession. Not a depression. A recession.
Meeting Warren Buffett
Joe is jetting off this weekend with Motley Fool Share Advisor Investment Analyst Scott Phillips to meet Warren Buffett.
Admittedly they’ll be just two of 35,000 people also meeting Buffett at the Berkshire Hathaway AGM, but they’ll certainly be closer to the great investor than most Take Stock readers.
Scott describes the Berkshire AGM as the investing highlight of a lifetime. He and Joe have been fortunate enough to attend a couple of times. They’ll be bringing next week’s Motley Fool Share Advisor weekly update from Omaha, Nebraska, and we’ll have a live-blog of the meeting up on Fool.com.au early on Sunday morning, Australian time.
Back to the banks…
We interrupt normal service to bring you add some “urgent and grave” reality to the situation…
Despite the rising market, and the euphoria over bank shares, our nation is facing some serious economic headwinds.
The mining boom is over. Unemployment is edging up. Our strong Aussie dollar is making our non-commodity exports uncompetitive, and hitting our in-bound tourism and retail sectors. And our federal budget position is “urgent and grave”, requiring spending cuts and/or tax increases, whichever party is in power.
I’m not one to spread doom and gloom. But I am one to caution that our banks are not a one-way bet, especially as slower economic growth is likely, and a recession is possible.
And if Joe’s right about what might happen to the returns on equity of our banks should Australia fall into recession, no fully franked dividend will save the bank shares from taking an almighty tumble.
Selling banks, buying growth
In the interests of full disclosure, although I’ve been selling bank shares, our family still owns shares in three of the big four, the odd one out being the accident-prone National Australia Bank.
But I have been diversifying — buying mid-cap companies with strong growth prospects both here and overseas — such that if our banking shares were to take that incredible haircut Joe refers to above, it wouldn’t be a portfolio-threatening experience.
More to a fully franked dividend than a bank…
Based on the share price performance of just a select few ASX large-cap companies, you could easily be forgiven for thinking they are the only ASX shares paying a fully franked dividend.
Let me enlighten you, dear Fools.
Looking down our Motley Fool Share Advisor scorecard of recommended stocks, I see a veritable smorgasbord of candidates paying decent dividends, trading at modest valuations, and companies that are growing their earnings — and not a bank stock in sight.
Investors have fallen in love with bank stocks, and see that love affair continuing for evermore. Call me a party-pooper, but I prefer a little diversity in my portfolio than just banks.
Until next time, as ever, I wish you happy, and profitable investing.
The Australian Financial Review says “good quality Australian shares that have a long history of paying dividends are a real alternative to a term deposit.” Get “3 Stocks for the Great Dividend Boom” in our special FREE report. Click here now to find out the names, stock symbols, and full research for our three favourite income ideas, all completely free!
The Motley Fool’s purpose is to help the world invest, better. Click here for your free subscription to Take Stock, 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. This article contains general investment advice only (under AFSL 400691). Bruce Jackson owns shares in ANZ, CBA, WBC and Berkshire Hathaway.