With the recent falls in the S&P/ASX200 Index (ASX: XJO) (^AXJO) local investors may be tempted to push more money back into dividend paying bank stocks, such as the big four banks.
However, when interest rates are purported to increase (even though it may be some months yet), big name dividend stocks can fall in value as investors begin to transition more money to cash, in a bid to pre-empt higher term deposit returns.
Don't be fooled
Bank stocks are no exception. Given their lofty valuations coupled with small amounts of bad debt (which is expected to rise with unemployment and continued downgrades in the mining sector) and sluggish credit growth, there's no reason to suggest they couldn't fall further.
According to the Australian Financial Review, CMC Markets analyst Ric Spooner said there is a chance the bank stocks could fall all the way back to where they were in May 2012. That would mean further price falls of up to 29% across the big four banks. Ouch!
I'm not nearly as bearish on the price of bank stocks just yet, but I do not believe they are a standout buy at current prices. Low interest rates and an army of self-managed super funds chasing dividend yield will be enough to provide a buffer on big name stocks until earnings begin to disappoint.
Despite that, the high share prices of Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC) and National Australia Bank Ltd. (ASX: NAB) aren't deserving of new money because they are unlikely to deliver market-beating returns in the short term. I believe the standout performer among the big four banks, from an earnings perspective, will be Australia and New Zealand Banking Group (ASX: ANZ).
Although ANZ's Asian strategy is coming into the spotlight as caution grows over emerging markets, which will potentially create volatility in ANZ's earnings. The bank derives a majority of its revenues from trade and capital flows, so volatility is unlikely to hinder the performance, but rather increase earnings in the short term. In the long run, increasing prosperity in Asian countries including Indonesia, Thailand, Vietnam, Hong Kong and China will bring a raft of new opportunities for the bank both at a retail and institutional level.
ANZ's domestic growth, in both mortgages and business lending, has begun to shine through in recent times. In 2013 the size of its mortgage and business lending portfolios grew by 7.4% and 7.9% respectively. Far outperforming its domestically focused peers Westpac and Commonwealth Bank.
It's all about the price you pay
Successful investing is all about the price you pay. Currently, ANZ's share price sits above its 10-year price-earnings trading average of approximately 12. In addition bad and doubtful debts sit below the 10-year average at $1.18 billion. However that number could be expected to rise in coming years which would have a detrimental impact on its share price, presenting a buying opportunity.
Its dividend payout ratio has risen in recent years and is currently 76%, NAB and Commonwealth Bank currently payout 77% of profits. So increases in payouts will likely come from earnings growth rather than a higher payout ratio or special or once-off payments to shareholders. Currently the price-book ratio of ANZ is 1.81 times, far higher than many of its global peers.
Foolish takeaway
Given the lofty valuations of big bank stocks and some of the obvious headwinds faced across the sector, it's hard to justify a long-term 'buy and hold.' ANZ looks most likely to outperform its peers in coming years as its plays catch-up in some domestic markets and pushes ahead with its Asian expansion. Despite the potential for higher earnings however, it's probably best left on watchlists for the time being.
