Interest rates remain stuck at just 2.5%, while inflation sits at 3% and bank stocks continue to increase their fully franked dividend payments. So, for most income-hungry investors, it's a no-brainer…
That is, take money from term deposits and savings accounts and put it in the banks' shares instead.
Sounds good, right?
Too many investors focus their attention on income and the relative "safety" of Australia's big banks, and completely forget that the banks' share prices could be drastically overvalued. After all, don't forget, interest rates started dropping in 2011.
Since then the market, gauged by the S&P/ASX200 Index (INDEXASX: XJO) has surged 30% and some of our blue-chip bank stocks have soared over four times as much!
Macquarie Group Ltd (ASX: MQG) has risen over 129% since November 2011 and paid out big dividends along the way. But it appears new investors have missed the bulk of its gains with management forecasting "broadly flat" earnings in FY15. As a result, I'm waiting for a lower entry point before buying in.
Another bank which has benefitted from low interest rates and the continual rise of Australian house prices is Westpac Banking Corp (ASX: WBC). Westpac is forecast to a pay a 5.2% fully franked dividend in the coming year. However Westpac, which relies heavily on Australia's housing market, is forecast by analysts to grow earnings per year at a very slow pace in coming years. Meaning, with shares trading at a lofty 14.4 times earnings and price to book ratio of 2.32, the downside risks are very large, in my opinion.
So what about the underperforming bank stocks?
The worst-performing bank stock of the past decade has been National Australia Bank Ltd. (ASX:NAB). NAB – which has exposure to the slow UK economy – is facing claims of misconduct whilst also trying to pay down a huge UK bad commercial loan portfolio. These problems are likely to hinder the bank's financial performance into the foreseeable future and may have long-term consequences. So, despite a huge 5.7% fully franked dividend, NAB is one bank stock which won't be finding its way into my portfolio.
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