Bank stocks are renowned for their safety and big dividend yields.
So it's little wonder why our big banks are pushing to record highs whilst interest rates are falling.
Indeed both Westpac Banking Corp (ASX: WBC) and National Australia Bank Ltd (ASX: NAB) expect interest rates to drop to just 2% in 2015.
With the Australian Bureau of Statistics today announcing our unemployment rate had reached a 12-year high of 6.3%, it's becoming increasingly likely the RBA will announce a rate cut or two.
For term deposit holders and savers, the time to transition money into higher yielding assets, like bank stocks, appears to be now.
Of the big banks, Westpac's often considered one of the safest for dividends. At today's prices it offers a fully franked yield of 5.6%, or 8% grossed-up.
However, whilst its dividend yield is very attractive in the low interest rate environment, investors need to understand that they may be at significant capital risk, if they overpay for shares.
So although it may pay a 5.6% dividend, its share price could actually fall by much more than 5.6% if the market loses its enthusiasm for bank shares.
Indeed, Westpac is richly priced. With a price to tangible book value of 2.73 and P/E ratio of 13 it's too expensive for a bank which is currently being forecast to grow earnings per share (EPS) by less than 2% per year for the foreseeable future.
In addition to being forecast to grow EPS at the slowest pace of the big banks, Westpac also lends the greatest proportion of funds to property investors. If APRA and the RBA plans to clamp down on investor lending, it'll have the largest impact on Westpac.
Then there's the problem of bad debts inflating profits and share prices. Obviously low interest rates make repayments on loans easier and when the cash rate is super low, profits can be artificially boosted by lower provisions for bad debts (i.e. debts that are in arrears greater than 90 days). When interest rates eventually rise, the trend will reverse. This usually coincides with more share market investors pulling money out of dividend stocks.
Buy, Hold, or Sell?
If interest rates drop in 2015, Westpac shares could jump higher as a result of increased demand for reliable dividend-paying stocks.
But it's important to note Westpac shares aren't cheap and the bank has a poor growth outlook and the largest proportion of loans to investors in a pricey property market. As the age old share market saying goes…
"Bulls get rich, bears get rich, and pigs get slaughtered."
Investors are advised to look at other dividend stocks ideas.