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3 ALARMING reasons to avoid buying big bank shares

There is perhaps not a more contentious topic in Australian investing than the big banks. It’s easy to see why so many investors disagree with us when we say they’re expensive. They’ve rewarded long-term shareholders exceptionally well.

For example in the past 10 years, the Commonwealth Bank of Australia (ASX: CBA) has achieved an annual total shareholder return (TSR) of 16.1%! That turns $10,000 into over $40,000!

But CBA shareholders aren’t alone. In fact, counterparts in Westpac Banking Corp (ASX: WBC) and Australia and New Zealand Banking Group (ASX: ANZ) have enjoyed an annual TSR of 13.4% and 12.4% respectively. I bet National Australia Bank Ltd’s (ASX: NAB) annual TSR of 7.5% would be enough to keep some investors happy. It wouldn’t be enough for me to walk away with a grin. But for some, I’m sure it would.

The problem is, for those investors who chose to buy in today, high single digit share price growth is what I believe you’ll have to get used to. You see, over the past two decades, the big banks have been the fuel tanks which have driven Australia’s rising prosperity.

Huge mining corporations, foreign investors and increased migration have all played a part in pumping and funnelling seemingly endless amounts of cash into the Australian economy. However, recently, a number of fundamental trends have emerged throughout the banking sector which I believe will result in lesser performances from the big banks in coming years.

1. Increased competition. Although the major banks’ control of the housing market increased to 84% in the past year, regional lenders and some mortgage brokers are driving competition for loans. Bank of Queensland Limited (ASX: BOQ), Bendigo and Adelaide Bank Limited (ASX: BEN) and Macquarie Group Ltd (ASX: MQG) are all seeking to increase their share of this lucrative market. As a result, profitability is falling and every big bank announced a lower Net Interest Margin for their 2014 half year.

2. No room for consolidation. No longer can the big four simply ‘rollup’ or buy out smaller rivals to grow earnings. Since around 2007, this, in addition to severe cost cutting, has been the tactic which drove the major banks’ earnings higher. CBA bought BankWest, Westpac bought RAMS and St.George (and created many others) and NAB launched UBank. In the near future, this type of growth will not be possible.

3. They’re expensive! The big banks are expensive. CBA trades on a price to book ratio of 2.94 and a price-earnings to growth (PEG) ratio of 1.75! Westpac is even worse, with a PEG ratio of 2.65. It’s important to remember it wasn’t that long ago (two years to be exact) that Westpac shares traded at only $20 per share and would pay a dividend equivalent to 8.1% fully franked!

Normally a high price tag is excusable if you’re getting a company which is likely to grow earnings strongly in coming years. But given the macroeconomic headwinds, current share prices and increased competition I believe the banks (perhaps with the exception of ANZ) will be lucky to grow revenues greater than 5% p.a. in the next 10 years. But I’m not alone, Credit Suisse analysts believe the big banks will grow earnings per share at only 8% in FY14, 2% in 2015 and 3% in 2016.

Here’s how you can still profit

I’m not tipping an end to the big banks’ growth altogether nor am I suggesting long-term investors rush out and sell their holding. But what I am saying is, each of the big banks are expensive given the likelihood of lower earnings growth in coming years and those who choose to invest at current prices must seriously consider how they expect the big banks to beat the S&P/ASX 200 Index (ASX: XJO) (INDEX: ^AXJO) from here on in.

However with over 2000 companies on the ASX, there are plenty of other great dividend stocks available. One stock I'm watching very closely is the, "The Motley Fool's Top Dividend Stock For 2014". It has as 7% grossed-up dividend yield and grown earnings for all of the past 8 years and is likely to continue! BEST OF ALL: It's yours FREESimply click here for your FREE copy right now.?

Motley Fool Contributor Owen Raszkiewicz does not have a financial interest in any of the mentioned companies. 

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