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Should you sell your bank shares?

In part due to the prevailing low interests rates, shares in Commonwealth Bank (ASX: CBA), ANZ (ASX: ANZ), National Australia Bank (ASX: NAB) and Westpac (ASX: WBC) have enjoyed strong runs in the last year. In that time, ANZ shares are up over 20%, and the other three have each enjoyed share price runs of over 30%.

Shares in the big four banks are trading on trailing dividend yields of 4.9%-5.6%. The fact that the dividend is fully franked makes shares even more attractive to investors, as does the perception that bank shares are a safe investment. It isn’t surprising that so many people own them in their superannuation funds.

Indeed, the big four banks dominate the Australian stock market. They make up four of the five biggest companies by domestic market capitalization. The chart below shows that during the last 10 years, the combined market capitalization of the big four has usually accounted for about 15%-20% of the total domestic market capitalization.

claude1

The chart above also shows that since 2003, relative to all the other companies traded on the ASX, the banks have never been considered so valuable by Mr Market. One factor that has influenced this trend recently is the decline in market capitalization of BHP (ASX: BHP).

However, even if you plot the combined market capitalization of the bank as a percentage of the total domestic market capitalization of the ASX, excluding BHP, you will still find the figure to be the highest it has been in the last decade, at almost 28%.

Warren Buffett has said that a comparison of total domestic market capital and gross national product (GNP) is probably the best single measure of whether a market is overvalued or not. Extending that logic, it is arguably worthwhile to consider the combined banks’ market capitalization as a percentage of GNP.

claude2

Mr Market seems to be saying that the big four banks are responsible for about a quarter of our gross national product. For all I know, this is correct, but if so, then that is considerably higher than 10 years ago (assuming the market was correct then). Whether true or not, investors should query how high that percentage can go in the future.

The price-to-book ratio of the big four banks is less attractive now than it has been in the last couple of years, and in my opinion bank shares are sufficiently richly valued that they may not even outperform cash in the short to medium term. They may simply not be worth the risk for those that may have to sell in the next five years.  Motley Fool contributor Peter Andersen has opined that Commonwealth Bank, in particular, is overvalued.

Foolish takeaway

If you believe that bank shares will appreciate at a rate greater than the GNP and the broader market, then you are predicting that banks will continue to increase their contribution to GNP and the total domestic market capitalization.  At some point, perhaps not for a while, this trend will likely reverse.

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Motley Fool contributor Claude Walker does not own shares in any of the companies mentioned in this article. Find him on Twitter @claudedwalker.

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