Are Australia’s big bank shares a screaming buy?

Credit: NAB

If you’re an investor in any of the big four banks, it’s fair to assume that you’d be pretty underwhelmed with their performance thus far in 2016.

All four of Australia’s major banks have declined heavily since the beginning of the year. None have performed worse than Australia and New Zealand Banking Group (ASX: ANZ), which has fallen more than 20% in just over three months, but Westpac Banking Corp (ASX: WBC), National Australia Bank Ltd. (ASX: NAB) and Commonwealth Bank of Australia (ASX: CBA) have all dropped between 15% and 18% as well.

Source: Google Finance

Source: Google Finance

Considering the historical returns from these businesses and the vital role that each plays in the local economy, the banks’ recent falls have divided investors.

In one camp, you have those who claim the banks are a screaming buy. As highlighted by The Australian Financial Review, Julian Babarczy, the head of Australian equities at Regal Funds Management, is among that group, claiming that the banks have “rarely been as cheap as they are today” over the course of the last three decades.

In many ways, he’s right. While the banks’ earnings have all skyrocketed, their price-book and price-equity ratios have declined. Meanwhile, their dividend yields are also increasing with NAB and ANZ both offering fully franked yields of 7.8% and 7.9% respectively. Those annual returns are far greater than the returns on offer from bank deposits right now, especially when you consider the tax credits that come attached to the dividends.

However, a second group of investors believes that the banks have become cheaper for a reason, and that those dividend yields may be somewhat unsustainable.

The banks’ strong earnings growth has been driven by low bad debt charges and a strong demand for borrowing. This has raised the attention of the regulators however, who are now forcing the banks to hold more capital against their loans. This, in turn, will impact their returns on equity (ROE) and likely their earnings as well.

Meanwhile, they could also be forced to reduce their dividend payout ratios in order to retain more capital and prop up their balance sheets. Just look at ANZ, who broker Morgan Stanley expects to cut its dividend by 17% to $1.50 per share this financial year. Suddenly, we’d be looking at a yield of 6.7% as opposed to its current 7.9% return.

Of course, that is still a great yield, and one of the best from Australian shares. When combined with the various other headwinds facing the business however, including the prospect of rising bad debt charges, conditions could still get worse from here for the bank.

There are also the various concerns regarding the bank’s toxic cultures, which threaten to ruin their reputations among customers. The damage inflicted on the businesses’ financial statements might seem minimal now, but it could be enough to deter some customers from their services in the future.

Foolish takeaway

There will likely come a time where the banks do represent great value for prospective investors, but the recent falls do not appear to be presenting such an opportunity just yet.

While some investors are focused solely on the dividend yields offered by the major banks, there are many other companies that are also offering great dividend yields today. The Motley Fool's renowned dividend investing guru recently revealed his newest dividend buy recommendation and short list of 3 Best Dividend Buys Now. Which means if you're reading this message right now, you're not on the list to uncover their names before they potentially go gangbusters. Simply click here to learn more about these shares.

Motley Fool contributor Ryan Newman has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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