National Australia Bank Ltd. (ASX: NAB) shares look like good value with a big 6.8% fully franked dividend yield.
Moreover, shares in NAB currently trade at just 12 times last year's profits per share, which compares favourably to the market's average price-earnings ratio of 17 times.
Is it time to buy NAB shares?
Relatively speaking, banks very often trade at below-market valuations. By design, banks are required to consume a lot of capital (in the form of deposits or debt from wholesale markets) and turn a profit (e.g. by issuing mortgages).
The leverage in-built in this process creates issues when markets take a turn for the worst, but boosts profits in the good times. As a result, investors often discount the shares during the good times, which is evident from its below-market price-to-earnings ratio.
Instead of using a price-to-earnings ratio many investors look to a bank's dividend yield, or dividends per share, to gauge their relative valuation. And rightly so, while NAB's earnings per share have bounced all over the place since the market crash of 2008, its dividends have been much more consistent. With a trailing dividend yield of 6.9% fully franked, NAB shares are some of the highest yielding on the ASX. That compares to Commonwealth Bank of Australia (ASX: CBA) shares, which sport a dividend yield of 5.4% fully franked.
Another — arguably more robust — technique is to use the price-to-book value as a measure of relative value. The 'book value' is what the bank's assets (i.e. mortgages, credit cards debts, office buildings, etc.) are worth, according to accountants. In the past, it was said that a good investor would buy shares in a bank for less than the book value of assets.
However, in the modern world of Australian banking, that may not be realistic. At today's prices, NAB shares have a price-to-book ratio of 1.5 times — far cheaper than Commbank's 2.2 times.
Outlook
Using the value of a bank's assets or dividends is okay, but neither will be any use to you if the bank were to collapse tomorrow. Therefore, it is imperative you glean an insight into its future.
Looking ahead, the robust economic engine of Australia looks to be tracking along nicely, with interest rates expected to tick up slowly over time. However, investors should remember that rising interest rates can dampen demand for loans and make repayments more difficult, leading to rises in bad debts. Hence the discounted valuations of bank shares over a cycle.
Nonetheless, NAB's asset sales are likely to refine its business model, making it more able to withstand the tail effects over the credit cycle and enable it to become more profitable in future years.
Buy, Hold or Sell?
NAB shares do not look cheap, using a price-to-book valuation. But they do offer a hearty dividend at a time when returns from asset classes like bonds and shares are expected to wither.
While I can see the appeal to owning NAB shares, personally, I think there are better opportunities available today. After all, you don't have buy every share on the market — your portfolio deserves only the best.
