Could National Australia Bank Ltd be a value trap?

Every investor has their definition of a 'bargain' investment and will determine a fair price to pay in a variety of different ways.

The father of value investing, Benjamin Graham, believed a large, prominent and financially sound company could be considered a bargain when its upside potential, determined through rigorous analysis, was at least 50% higher than its market price.

These types of opportunities are rare in bull markets but in market lows can be commonplace. In his book, The Intelligent Investor, Graham notes the two major sources of undervaluation are:

1. Currently disappointing results
2. Protracted neglect or unpopularity

However, neither of these should be used in isolation. Indeed there are a number hurdles an investment must clear before we proceed any further in determining whether, or not, it can be considered a potential bargain. Here's what you also need note:

3. The company must have a strong track record, in terms of earnings, over the past decade or more
4. It must also have sufficient size and financial strength to meet any future setbacks; and
5. It must be selling well below its past average price and average price-earnings ratio (PER).

NAB: A Bargain and Basket Case?

Let's start from the top with our biggest bank by assets, National Australia Bank Ltd (ASX: NAB).

1. The bank recently announced disappointing results, which included profit falling 10% year-on-year. So far, so good.
2. It is a serial underperformer, with its share price increasing just 22% in the past 10 years. Unsurprisingly, it trades on the lowest price-book ratio and PER of its peers. So we can tick this one off too.
3. In the past decade however, NAB's earnings per share cannot be considered strong and reliable. So it does not pass this test.
4. The bank currently has a Common Equity Tier 1 (CET1) ratio of 8.63%. This is good, but not great. In the near future, it'll likely be required to have a greater capital buffer for adverse market conditions, which may further dampen its already lacklustre levels of profitability.
5. NAB's 10-year average annual PER is 12.7. Currently, shares trade on a trailing PER of 15.85. That is a significant premium to its historical levels.

For the sake of correctness, it's also important to note the trend in book value. The 10-year average price-book ratio, at the time NAB reported its full year results, is approximately 1.92. Its current price-book ratio is 1.64. Indicating the market is currently pricing its assets (remember banks consider loans as assets) less than it has historically.

Should you buy?

Unfortunately NAB doesn't pass the five-point test above and is certainly not in a trading range where I could safely say its intrinsic value is 50% more than its market price. Despite new CEO Andrew Thorburn's best attempts, in my opinion, NAB cannot be considered a 'bargain' and could actually prove to be a value trap for unwitting investors focused on its large, fully franked dividend.