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3 reasons bank shares are no bargain

Shares in Australia’s big four banks have enjoyed a startling run in the last 12 months. Shares in Commonwealth Bank (ASX: CBA) are up 25.4%, ANZ (ASX: ANZ) is up 18.4%, Westpac (ASX: WBC) is up 24.3% and National Australia Bank (ASX: NAB) is up 29.4%.

Property prices in Australia are heating up again and interest rates are low. This is a powerful combination for the banks, because it means that people can afford to borrow more (or think they can) and people are inclined to borrow more, because property is more expensive. The direct result is that banks can lend more money.

After the GFC, Australians concentrated on paying down their personal debt, and the banks temporarily found it more difficult to generate earnings. With the gradual return of consumer and business confidence, borrowing money is getting back in vogue. Nonetheless, I don’t think bank shares are the best investment.

Here’s why you shouldn’t buy bank shares right now:

1. For every buyer there is a seller, and investors should always ask what they know that the seller doesn’t. For retail investors, it’s virtually impossible to have an informational advantage over full-time professional analysts.

Indeed, it was recently reported that a number of large US hedge funds were short-selling the Australian banks. Investors should consider carefully whether they fully understand bank valuations, or if they are simply following the advice of others who claim to. If you can’t value a share (even approximately), is it wise to be buying it in the first place?

Charlie Aitken of Bell Potter has asked the question: “Has anyone noticed that bad debts are falling and that the bank shares are priced by mum and dad investors who own 50% of each stock?” He makes a good point, and the shorters may well get burnt. But this fact also means that the time to buy is when “mum and dad investors” are running scared, not when they are optimistic.

2. Bank shares aren’t as safe as many people think. Granted, Australia has the ‘safest’ banks in the world. Arguably, this justifies the fact that they are so expensive. The only problem is that everyone in the world knows this now. Interest rates are also very low (for Australia). This has led many superannuation funds (both institutional and self-managed) to buy bank shares, as they pay fully franked dividends far in excess of current interest rates.

However, when interest rates rise (and eventually they will) the dividend will become less attractive. This could also impact the ability for the banks to grow their loan books. Investors must not forget that money in bank shares is not as safe from as money in a bank account.

3. The share prices of the banks have been buoyant of late. As I wrote in this article, the big four banks now represent a historically high percentage of the market capitalization of the ASX. Indeed, no one could seriously argue that the prospects of the banks have improved as much as their share prices have; big, established businesses rarely change that quickly.

Share prices rise for a variety of reasons. Two common reasons are: a) the intrinsic value of the company increases, and b) the market has a more optimistic view of what the intrinsic value will be in the future. In the last year, the latter reason has driven the bank share price rises. It is difficult for the banks to grow profits quickly (as a percentage) because they already make so much money.

Foolish takeaway

The time to buy bank shares was 12 months ago (or before that). Investors will struggle to beat the market if they follow it. As mentioned at the start of this article, the banks are currently experiencing favourable conditions. However, in my opinion these conditions are largely priced in. There are many other companies to invest in, and investors should consider adding less well-known stocks to their portfolio.

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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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