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Is National Australia Bank Ltd. ridiculously cheap?

National Australia Bank Ltd. (ASX: NAB) shares look cheap.

  NAB Peer-group average
Price-Earnings Ratio (P/E)(times) 11x 12x
Dividend Yield (%) (fully franked) 7.4% 6.8%
Price-Earnings-Growth (PEG) 1.9x 2.7x

As can seen from the table above, shares of NAB appear good value relative to its peers, which include Westpac Banking Corp (ASX: WBC), Commonwealth Bank of Australia (ASX: CBA), Australia and New Zealand Banking Group (ASX: ANZ), and smaller regional players.

Is NAB ridiculously cheap?

It’s important to consider what goes into these numbers before drawing any conclusions about NAB’s value.

NAB has a lower (better) price-earnings ratio (P/E) than its peers. However, the P/E is an unreliable indicator of value, especially for intensely cyclical businesses, such as banks.

The market or S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) currently boasts an average P/E of 16.5x.

The price-earnings growth ratio (PEG) factors in forecasts for next year’s profits. It is arguably a more reliable measure of value. Analysts prefer a lower PEG ratio to a higher PEG. With a ratio of 1.9x, NAB’s shares appear better value than its peers when we factor in earnings per share forecasts.

Finally, dividend yield is a crude measure for most shares (dividends are optional — management isn’t compelled to pay them every year), but it is arguably a robust valuation measure to benchmark established companies over a cycle. And at the end of the day, few investors would complain if NAB could only pay its enormous dividend four out of every five years. At 7.4% — fully franked — NAB’s dividend yield is a compelling feature for income-starved portfolios.

Cheap or ridiculously cheap?

Using a dividend discount model (DDM) to value NAB shares in absolute terms a value of around $28 does not appear excessive. That implies a 4% margin of safety (the difference between estimated value and market price).

In my opinion, NAB shares are not ‘ridiculously’ cheap at today’s level, just cheap relative to peers and the market. Therefore, NAB shares are not a standout buy. Investors should wait for a more compelling entry point.

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Motley Fool Contributor Owen Raszkiewicz does not have a financial interest in any company mentioned in this article. Owen welcomes -- and encourages -- your feedback on Google+, LinkedIn or you can follow him on Twitter @ASXinvest.

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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