Should you buy NAB or ANZ?

Every investor has their own strategy when it comes to buying and selling stocks. Irrefutably, however, the best strategy goes something like this: buy in the troughs, sell at the peaks.

As every seasoned investor knows, picking the lows and highs is harder than it seems, which is why long-term investing has proven to be one of the best methods to beat the market. Picking good stocks and buying at the best prices is a sure way to minimise downside risks and maximise the upside.

Here in Australia it seems we’ve become accustomed to rising house prices, constant and sustainable GDP growth and low levels of unemployment — all of which have given more reasons than not to add the big four banks to your portfolio.

Coupled with falling interest rates in the past two years, the big banks have proven to be highly lucrative investments for investors searching for both capital gains and dividends.

In terms of yield, National Australia Bank (ASX: NAB) has the highest returns. In addition it trades on the lowest multiples of any of the big four. Perhaps the biggest concern for NAB is its capital position. Of the big four it has the lowest amount of tier 1 capital yet pays out a dividend equivalent to 76% of earnings.

The company’s failed UK venture (although admittedly it is seeing some sort of recovery) has resulted in poor returns on equity and credit margins. NAB could be a great turnaround story, particularly with its large proportion of business revenues and relatively small amount of the domestic mortgage market, but at current prices it’s not cheap and savvy investors know even the best companies are not a buy at any price.

However, investors are generally willing to ‘pay up’ for companies that are more leveraged to growth. ANZ (ASX: ANZ) is the big four bank most likely to grow at a faster pace than any of its Australian peers. In the long term, ANZ’s presence in Asia through its ‘Super Regional Strategy’, which it launched in 2007, will reward shareholders. However it is also not without its risks.

A point of differentiation between NAB’s, Westpac’s (ASX: WBC) and ANZ’s Asia strategies is the latter is focused on competing in the region rather than taking advantage of trade flows to and from Australia. ANZ is growing its revenues from the region and hopes to cash in between 25% and 30% of the group’s total earnings from it by 2017.

Many analysts have said this could be close to impossible if the bank wishes to grow its earnings organically and would almost certainly require an acquisition. However, growth for growth’s sake is not sustainable. CEO Mike Smith recently responded to speculation the bank was planning to buyout a Hong Kong lender by saying it was “too expensive.” For long term investors, that’s music to our ears.

Outside of Asia, ANZ is growing its loan portfolios and its return on equity here in Australia is good (considering it’s a bank). Although it maintains a dominant position in Australia as well as New Zealand, it has room to grow.

Foolish takeaway

ANZ is my first choice of the big four banks simply because it has long-term potential, pays a strong dividend and is headed by one of the best bankers in the world. However, as good as it is, I do not believe it should be a buy at current prices. Although I believe the rush on yield still has a long way to go (I don’t expect interest rates to move up until 2015), investors should be waiting for a more reasonable entry point.

Investors who buy bank stocks today are assuming we’re not likely to experience a recession or financial crisis anytime soon. Time has proven again and again those setbacks are the best time to buy good banking stocks.

A bullish case for the banks 

If you believe house prices can continue to go up without wage increases whilst bad debts and unemployment stay low, then perhaps the banks are a good investment for you. However if you think there is a chance they won’t stay rosy, then my advice is to limit your exposure.

Christopher Joyce, a leading economist, fund manager and policy advisor, recently said this about the state of Australia’s housing sector in The Australian Financial Review, “The bottom line is that we may be only six months away from Australia’s housing market being more expensive than it ever has been… The potential for a future correction is significant.”

I am not predicting a recession or housing market collapse but we are seeing house prices rising heavily. Even if it is a recovery from GFC lows, the banks are already expensive. It’s not the right time to buy any of the big four.

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Motley Fool contributor Owen Raskiewicz does not own shares in the companies mentioned here.

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