Investors beware – banks are expensive!

Banks are inherently risky businesses so investors need to consider more than just the dividend yield.

According to Matt Sherwood the head of investment research at fund manager Perpetual Limited (ASX: PPT) investors should be wary of buying local bank shares at current prices warning that they appear expensive and are far from “risk-free.”

Investor Daily reports that Mr Sherwood suggests Aussie banks today trade at a 30% premium, compared with a 30% discount 15 years ago against global peers.

Search for Yield

Mr Sherwood identified investors near obsession with dividend yield since the GFC as part of the cause of Australian banks trading at a premium. While noting that Aussie banks do have a lower earnings risk profile than their global peers he also stated that:

“Today, they trade at a 30% premium. It will therefore cost you 30% more to buy a dollar of earnings from an Australian bank than it does in other parts of the world.”

Valuation

Perpetual is known for bringing a robust approach to the valuation of companies which delves a lot deeper than simply reviewing the dividend yield and the price-to-earnings (PE) ratio of a stock. There are many metrics to value a company on and when it comes to highly leveraged businesses such as banks, the balance sheet is a good place to start. Aiming to buy banks when they trade on less than one times book value is a good rule of thumb. Here are the price-to-book value (P/B) ratios for the big four banks according to Morningstar Research:

Australia and New Zealand Banking Group (ASX: ANZ) 1.78 times

Commonwealth Bank of Australia (ASX: CBA) 2.59 times

National Australia Bank Ltd (ASX: NAB) 1.76 times

Westpac Banking Corp (ASX: WBC) 2.02 times

Foolish takeaway

No investment should be considered sacred in a portfolio. Even for long-term, buy-and-hold investors it is important to re-evaluate your portfolio from time to time as business economics and prices are constantly changing, which can have a bearing on the long-term prospects of your portfolio holdings.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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