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Should you ignore the ~9% yield offered by the big banks?

The share prices of the big banks have been falling and if there is a silver lining it’s that their yields have gone through the roof!

If you included franking credits, big bank stocks like Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB) are generating an average yield that is topping around 9%.

That’s a whole lot of dividends from some of Australia’s most established and well capitalised institutions.

I can’t remember a time big bank yields were this fat and juicy except for the GFC. But this isn’t the GFC and the global banking system isn’t tittering on collapse.

This is why analysts who are supporters of sector think the banks are cheap as these blue-chip shares are trading at a nice discount to the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) on top of their deliciously generous dividends.

Should you be seduced by the argument? The short answer is “no” because history has taught me that you never look at valuation when there are governance issues clouding a stock or sector. In many cases, valuation (including yield) is just irrelevant as this doesn’t address the root cause of the de-rating.

You are effectively trying to pick the bottom if you bought shares in the big banks now. If you are good at catching falling knives, then don’t let anyone dissuade you from the endeavour. But I’ve lost too much blood in the past trying to catch falling stars for their enticing valuations.

The fact is, you need to be very comfortable with the risks that are building in the sector. These risks may not look as dramatic as during the GFC but in some ways they are worse.

At least during the global crisis, the federal government was pumping house prices through its stimulus program. This time around, regulators are trying to cool the market on worries that borrowers have overextended themselves – and government won’t want to be standing in the way of that.

Add on rising bank funding costs, stagnant wage growth, a cooling housing market, increasing competition from non-bank rivals and the Banking Royal Commission into the mix and you can see why I am dodging knives and not trying to catch them.

Banks are getting both their top and bottom lines squeezed and anyone who buys bank stocks at this juncture will need to be reasonably confident that they predict the future – particularly potential regulatory changes from the Royal Commission.

I have no doubt that there will be a time to jump back into the sector. But I suspect this won’t be till August/September at the earliest.

In the meantime, investors are probably better off looking at the Motley Fool’s best blue-chip stock picks for 2018.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, National Australia Bank Limited, and Westpac Banking. The Motley Fool Australia owns shares of National Australia Bank Limited. 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 Scott Phillips.

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