4 ways to value the big banks

Taking an objective stance on big bank shares renders an unattractive investment case.

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Australia’s big four are no bargain.

Our biggest banks – including the Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB) – have each welcomed low interest rates and low unemployment with growing cash profits but that doesn’t make them a buy.

In the midst of the run-up in share prices, investors would be mistaken to believe they are ‘good’ value at current prices. They are not.

Here are four figures big bank investors must consider before buying shares. Note: Figures taken from their latest full-year reports.

Price-Book Ratio

The price-to-book ratio compares the current market price of a company to its book value. A value greater than 1 (which is usual) means the market is willing to pay a larger amount than the balance sheet value attributed to the assets of the company.

Commonwealth Bank: 2.69

Westpac: 2.22

National Australia Bank: 1.89

ANZ Banking Group: 1.95

As can be seen, Commonwealth Bank trades significantly richer than its peers, proving investors are willing to pay a high price for a slice of the company. By comparison, over in the United States Wells Fargo & Co (NYSE: WFC) has a price-to-book ratio of 1.56.

Price-Earnings Ratio (Current | 10-year Average)

The price-to-earnings ratio is a valuation ratio of a company’s current share price compared to its per-share earnings. The higher the value, the less purchasing power an investor has in respect to a share of profits.

Commonwealth Bank: 15.89 | 13.14

Westpac: 14.91 | 12.95

National Australia Bank: 13.85 | 12.48

ANZ Banking Group: 14.77 | 12.41

Wells Fargo trades on a P/E of 11.7.

Charge for Bad Debts (2012 | 2013)

Bad and doubtful debts are monies owed which the bank deems unrecoverable. These will likely rise when unemployment and interest rates begin to increase.

Commonwealth Bank: $1,089 million | $1,082 million

Westpac: $1,212 million | $847 million

National Australia Bank: $2,734 million | $1,810 million

ANZ Banking Group: $1,198 million | $1,188 million

In their most recent reports, bad debts have continued to fall, increasing profits.

Net Interest Margins (Current | 10-year average)

The net interest margin is the difference between the interest income generated by the banks and the amount paid out to their lenders, relative to their assets. It is a key measure of banking profitability.

Commonwealth Bank: 2.13% | 2.27%

Westpac: 2.14% | 2.23%

National Australia Bank: 2.02% | 2.37%

ANZ Banking Group: 2.22% | 2.33%

In the fourth quarter of 2013, Wells Fargo has a net interest margin of 3.26%. As can be seen, National Australia Bank’s UK assets continue to weigh down the group’s overall profitability.

Foolish takeaway

More than historical figures and simple ratios go into an investment case, but it’s important to understand the current prices across much of the industry. Across all valuations the big banks don’t appear cheap. In this Fool’s opinion, the banks appear expensive at a time when they’re least profitable (on an interest charge basis) despite having falling bad debts, and as a result, do not warrant a ‘buy’ rating at current prices.

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