Blue-chip companies are one of the most vital elements to any portfolio. That is because they are well-established in their respective industries, they maintain a solid balance sheet and have the capacity to remain functioning through the market’s good times and bad.
However, just because they represent strong businesses doesn’t make them an automatic buy. As is the case with any investment prospect, the shares must be trading at a reasonable price from which they could outperform the broader S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) over the long-term.
As a perfect example, it seems that investors are still being drawn to the lure of banking major Westpac Banking Corp (ASX: WBC). On the surface, it could be seen as a very attractive investment. After all, as is the case with its peers, Westpac is likely to smash last year’s record profit when it reports later in 2014, thanks to the low interest rate environment and low bad debts. In addition, it boasts a fully franked yield of 5.2%, which is attractive by any investor’s measure.
The problem is, the stock is currently overpriced and stands little chance of outperforming the broader market. It is sitting just below its all-time high of $34.98 which it set in October last year and is trading on a P/E ratio of 14.8 times (its 10-year average is just under 13). This is even more expensive than National Australia Bank Ltd (ASX: NAB) or Australia and New Zealand Banking Group (ASX: ANZ) which are trading on multiples of 13.6 times and 14.3 times respectively. It is also just below Commonwealth Bank of Australia’s (ASX: CBA) P/E ratio of 14.9.
As previously mentioned, the banks’ profits are being propped up by record low interest rates and the accompanying low bad debts. Interest rates will inevitably rise and bad debts will climb alongside them which will impact profitability. Likewise, new banking regulations could make it difficult for them to maintain their bumper dividend distributions in the medium-term which could see investors take their money elsewhere, pushing the value of shares downwards.
Australia’s banks are rated amongst the most expensive banks in the world. Although they each represent quality, well-run businesses which are recognising enormous profits, they are still not a good buy at today’s prices. However, if you feel you absolutely must include a bank stock in your portfolio, ANZ Group is the most attractive given its growth prospects in Asia.