As individual investors, we must beat the market. Otherwise, what's the point? Sure, I'll admit we don't have to beat it every year but over the long term if we cannot beat the market than a switch to a low-cost index fund is logical.
Whilst that might sound a little harsh, I believe every investor should consider investing for themselves or, at least, try to understand the stock market because the rewards are second to none.
Just ask those investors who've owned shares in Westpac Banking Corp (ASX: WBC) or National Australia Bank Ltd (ASX: NAB) for a long time. They've been rewarded with a growing tax-effective income stream and capital gains.
But the question on everyone's mind is: Are they a good buy today and can the good times continue?
I believe the answer is no. I mean, the good times will continue and each bank will be more profitable in five or 10 years' time, but at their current prices I think both stocks will fail to beat the market.
Westpac, the larger of the two banks by market capitalisation, currently trades at a substantial premium to the value of its asset base, in my opinion. Using a capital asset pricing model, fair value for the bank would be 10% less than its current market price. But I think that's generous because the current record low interest rate environment has skewed valuations.
At current prices, Westpac pays a dividend yield equivalent to 5.2% (which could nearly be matched by smaller, growing companies – as you'll see below), trades on a price-book ratio of 2.32 and price-earnings to growth (PEG) ratio of 2.95. It's not a buy.
NAB, our largest bank by assets and fourth largest by market capitalisation, has failed to keep pace with the growth of its peers over the past decade. This can be put down to poor asset quality as a result of the GFC having a large impact on the UK economy.
However, investors who are hoping to capitalise on its seemingly cheap valuation should think again. In the short term, the bank faces a number of headwinds including:
- A Scottish independence vote – which will affect its subsidiary, Clydesdale Bank
- Misconduct related charges in the UK; and
- Paying down its "run off" portfolio, which is a large portfolio of bad UK commercial property loans
NAB shares change hands on a trailing fully franked dividend yield of 5.7%, price to book ratio of 1.89 and PEG ratio of 2.13. Whist, in contrast to Westpac, these numbers could seem appealing, it's important to note the bank has a lower net interest margin (a key measure of bank profitability), cash return on equity, higher efficiency ratio and cost to income ratio.
Therefore, you're paying less but getting poorer quality. Although I do acknowledge NAB has the possibility for upside surprises, I do not believe it's a buy at today's prices.
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Investors, like you and I, deserve only great companies trading at bargain prices. In my opinion, NAB and Westpac are great businesses but they're not trading at good prices and are unlikely to beat the market from here.
