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You should not buy the big four banks – here’s why

Although Australia’s major banks didn’t get off to the greatest start to the year as the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) plummeted, they have certainly made up for it since early February.

In fact, Westpac Banking Corp (ASX: WBC) and Australia and New Zealand Banking Group (ASX: ANZ) have today set new all-time highs, climbing to $35.70 and $34.57 respectively. Commonwealth Bank of Australia (ASX: CBA) is also hovering less than 1.5% from its high of $79.88. Meanwhile, although National Australia Bank Ltd (ASX: NAB) is still sitting well below its levels achieved pre-GFC, its shares are also approaching a multi-year high.

Although the stocks are trading at such high premiums, you might be wondering if there is still value to be realised. After all, the four banks are expected to smash last year’s combined profit of $27.3 billion when they report later in the year, while interest rates are also expected to stay low for some time yet, which should lead to more loans. Throw in the fact that they still yield an average 5.1%, fully franked and shares could well climb higher from today’s prices.

The problem is, the gains could soon come under pressure. Given the low interest rate environment, each of the banks are aggressively competing for mortgage customers by offering significant discounts on home loans. This will impact margins which will eat into profitability. What’s more, one of the primary drivers behind the banks’ incredible profits has been low bad debts. Interest rates will inevitably rise (some economists predict that could be some time later this year) which will see bad debts climb, impacting the banks’ earnings in the medium-term.

Currently, each of the banks holds a P/E ratio well above their 10-year averages. Unfortunately, it looks unlikely that they will be able to live up to these high valuations over the long term, which means the shares are best avoided for now.

Foolish takeaway

Most investors consider adding the banks to their portfolios due to their defensive natures, their incredible dividends and their dominance in the market. While they are not presenting as being good value today, you could also consider buying into Telstra Corporation Ltd (ASX: TLS) or Woolworths Limited (ASX: WOW).

Attention bank shareholders!

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned.

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