With both Westpac Banking Corp (ASX: WBC) and National Australia Bank Ltd. (ASX: NAB) expecting two interest rates cuts in 2015, dividends will again be the focus of investors' attention.
Indeed with term deposits offering around 2.5% per annum now, imagine what the returns will be like if (when) the cash rate drops to 2%.
In recent years a popular tactic employed by many investors trying to escape low rates on term deposits has been to transition money from savings accounts into big bank shares.
It makes perfect sense, doesn't it?
Why would an investor accept 3% on a term deposit when they could get 5.5% (with franking credits) by simply buying shares in the same bank?
Unfortunately, it's not that simple and bank stocks – like any – carry significant capital risk. That is, a sharp 5% or 10% downward movement in the banks' share price could quickly wipe out the perceived benefit of their bi-annual dividend.
Of the big four banks, NAB currently has the largest dividend yield. At today's price of $32.30, its shares trade on fully franked dividend yield of 6.1%. By adjusting for franking credits, the dividend yield becomes a whopping 8.7%.
What's more, if analysts' projections are correct, the next year's worth of dividends place it on a grossed-up yield of 9.2%!
Buy, Hold, or Sell?
Dividends are only part of an investment thesis and given NAB's troubled past and ongoing exposure to the UK and USA, I'd rather wait for a cheaper price before hitting the buy button.
Whilst analysts are expecting a bounce back to profit growth in 2015, shares currently trade on a price to tangible book value of 1.84 and P/E ratio of 15.2.
If bad debts start rising (NAB itself is predicting unemployment to climb to 6.75% in the next 12 months) the bank's earnings per share (used in the P/E ratio) will be adversely affected.
So although they appear cheap on a P/E basis now, if its earnings drop and investors' insatiable desire for dividends reverses, it'll likely experience significant selling pressure. It's at those times when savvy investors want to stock up on the big banks, not now.
