Are the banks expensive?

Fresh from reporting a record annual cash profit of $7.1 billion, Westpac Banking Corporation (ASX: WBC) has pleased shareholders no end with its regular 88 cent fully franked second-half dividend, plus a special dividend of 10 cents a share.

That takes the full year dividend payout to $1.94, up from $1.66 in 2012. On top of that, Westpac’s shares have rallied more than 36% over the past twelve months. As the company’s chief executive, Gail Kelly, noted, “In total these dividends put an average of $2,200 into the pockets of our half a million shareholders this year. It will also benefit the superannuation of millions of Australians, which is great news for the Australian economy”.

No wonder bank shareholders are jumping for joy.

Westpac of course is the last big bank to report for the 2013 financial year. Last week, National Australia Bank (ASX: NAB) posted a $5.9 billion profit, while ANZ Bank (ASX: ANZ) reported a $6.5 billion full year profit. Commonwealth Bank (ASX: CBA) announced a record annual profit of $7.8 billion in August. Combined, the big four have posted profits of $27.4 billion over the past financial year.

But when you consider that the big four banks hold assets totalling close to $3,000,000,000,000 (3 trillion) on their balance sheets and are generating returns on those assets (ROA) of 1% or less, that $27 billion seems quite measly, especially when compared to other banks around the world. While many commentators have suggested that the banks are still generating mid-teen returns on equity (ROE); thanks to their leverage (borrowings) their ROE is not that impressive compared to say, other large industrials with lower levels of debt. As an example, supermarket retailer Woolworths (ASX: WOW) generates a return on assets of over 10%, and a return on equity of 36%.

Additionally, the banks in total have managed to grow earnings in 2013 by just 5.7%, while 2012’s earnings growth was just 1%. If low levels of growth continue or even fall, it’s hard to justify their current share prices. The main culprit has been credit growth, which has been subdued for a number of years. Banks rely on credit growth to a large extent to grow earnings and dividends.

To make matters worse for the banks, the Australian Prudential Regulation Authority (APRA) is finalising new requirements for banks, which will likely see them forced to hold additional capital in reserve, to protect them from an unforeseen meltdown. APRA has also warned the banks about their dividend payout levels.

Foolish takeaway

Many investors forget how risky banks can be. 20 years ago, Westpac almost went under after posting a loss of $1.6 billion as a result of an economic downturn. Now is not the time to be putting your nest egg savings into highly capitalised, high-risk stocks like the big four banks.

It's not as high risk as a bank, but every Aussie investor knows Telstra. Only the smart money is on the move now... Discover whether you should buy, sell or hold Telstra shares in our brand-new report, written by a top Motley Fool analyst. It's free, click here for your instant download!

Motley Fool writer/analyst Mike King owns shares in Woolworths. You can follow Mike on Twitter @TMFKinga


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