Shareholders in National Australia Bank Ltd. (ASX: NAB), Westpac Banking Corp (ASX: WBC) and Australia and New Zealand Banking Group (ASX: ANZ) have had a year to forget.
That's because their share prices are down 9%, 2.3% and 2.5%, respectively.
Source: Google Finance
Indeed with dividends included, an investment in Westpac or ANZ has returned between 2% and 3% but only if you assume inflation was zero, which it wasn't.
But don't say I didn't warn you, on many occasions throughout late 2013, and early 2014 I told readers to avoid the big banks.
Then – as now – the banks were trading at prices which accounted for significant future earnings growth. So when their record profits finally came around, there was little reason for institutions to 'rerate' the stock and drive up prices.
In addition a meaningful amount of the big banks' profit increases were a result of falling bad debts. Investors must remember, low interest rates will not be here forever.
Are they cheap?
Ultimately to be successful in the sharemarket, an investor needs to buy shares of quality companies when their cheap. This not only minimises downside risk but enables the shareholder to benefit from a potential return to the mean. Conversely purchasing shares at the top of a company's cycle will maximise the potential for loss.
Currently the banks may look cheap, given their P/E ratios and whatnot, but it's not appropriate to value them in such a way. Nor are dividend yields an appropriate measure of profitability.
For example if you only bought the Australian bank with the lowest P/E ratio and largest dividend yield a decade ago, your returns would be terrible when compared to an investor who did the opposite. NAB has, for longer than I care to remember, traded on the lowest P/E ratio and highest dividend yield, whilst Commonwealth Bank of Australia Bank (ASX: CBA) has always been the most expensive.
In the past 10 years shares of CBA are up 160%, NAB is up 11%.
Indeed investors should value bank stocks using much more than simple P/E ratios and dividend yields and be very cautious of any financial advisor who bases their investment decision on such metrics.
Personally, I look at profitability (ROE, net interest margin, efficiency ratio etc.) and if I want a quick gauge of valuation, I use a price to tangible book ratio. At today's prices, none of the big banks appear to be good value.
What to watch out for in 2015
Since our last recession in 1991, Australians have become accustomed to increasing house prices, low unemployment and non-stop mining investment.
Moving into the new year, investors should be conscious that unemployment is tipped to rise, resources-lead investment is falling off (in a big way), confidence is low and house prices are coming off the boil. All of which will impact the big banks.
However I'm not going to sensationalise it.
Indeed the big banks aren't doomed if unemployment rises above the government's forecast of 6.5%, or if APRA demands higher capital requirements…
If APRA does raise the capital requirements to between 10% and 11.6%, as the Murray Inquiry indicated as a plausible range, the impacts on the big banks will be minimal. In fact a 1% increase to the current 8.3% minimum requirement would raise the average interest rate on a loan just 0.1%.
Buy, Hold, or Sell?
For individuals buying their own shares, your goal should be to beat the market – i.e. the S&P/ASX 200 (INDEX: ^AXJO) (ASX: XJO) or similar – because if you don't, why not just buy a low-cost index fund and save yourself the time?
Given the current outlook for the economy and their high share prices, I wouldn't be prepared to buy any big bank stocks today. In the coming year I expect the banks to continue their lacklustre performance of 2014.
