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3 reasons why I’m steering clear of Westpac Banking Group

In the short run the market is a voting machine but in the long run, it is a weighing machine.” – Benjamin Graham.

With interest rates so low, it’s a normal reaction of many investors to think that transitioning their money from term deposits, paying say 2.5% interest per year, into the stock of that same bank, likely to be paying around 5% per year, is a great idea.

And Australian property prices only go upwards, right? And our banks are too big to fail after all, aren’t they?

If you’ve been around for long enough, you’ll know the Australian economy isn’t bulletproof. Just think back to the recession of the early 1990’s and the widespread effects it had on businesses and households alike.

In 2006, former Reserve Bank of Australia Governor Ian Macfarlane described the recession as one which, “was dominated by financial failure.” Falling asset prices meant that loans could not be repaid, thus transferring the distress to financial institutions.

So what’s all this got to do with Westpac Banking Corp (ASX: WBC)?

The answer: Everything.

You see, since that recession (when unemployment rose well over 10%) 23 years ago, Australia has had a great run. Led by both the mining and property booms, Australians have done extremely well for themselves.

Banks, such as Westpac which controls nearly a quarter of all mortgages and 19% of business banking in Australia, have benefitted twofold.

But now, investors have extrapolated the banking industries past successes long into the future, and have done so believing there’s growth ahead.

How else could someone put a buy rating on a $110 billion institution like Westpac, when its share price is already up 38% in the past two years?

Sure, in the short run you may be seemingly well rewarded for basing your investment case upon past successes. However failing to even consider the risks involved would be asinine, to put it politely.

Indeed, bank stocks aren’t immune from equity market vicissitudes and acting with equanimity during a severe market setback is lot easier said than done. It’s a lot harder when you haven’t done your research.

So what are my three reasons for avoiding Westpac?

Firstly, at today’s prices, shares in Westpac – along with peers such as Commonwealth Bank of Australia (ASX: CBA) and Australia and New Zealand Banking Group (ASX: ANZ) – are grossly expensive.

Secondly, growth will be harder to come by in the near term. Especially for domestically-focused major banks like Westpac. Consensus earnings estimates for the bank are less than 3% per annum over the next three years. Paying over 3.03x tangible book value for 3% growth per year, no thank-you.

My last reason for avoiding Westpac is relatively simple. There’s a whole heap of better opportunities on the market, so why I would take the risk? Even if I was bullish on the stock, it’s unlikely I’ll be afforded a variant perception significant enough to allow me to see what the other 50 analysts covering the stock, cant. So I have no advantage.

Buy, Hold, or Sell?

I’m not predicting a recession, crash, correction or even the collapse of Westpac Banking Corp. Indeed, if you’ve held the stock a while, you’ll likely have done well. Take my advice with a grain of salt.

But for new investors and those who’ve bought Westpac at prices anywhere near today’s, I believe the chances of your investment outperforming the market from here are very slim. In addition when we factor in the opportunity cost associated with accepting the status quo, there’s absolutely no reason why we need to hold the stock at all.

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

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