With the National Australia Bank Ltd (ASX: NAB) share price up 54% over the last 12 months, investors may be wondering if its shares still good value. But how do you value a bank share?
How do you value the NAB share price?
When it comes to valuing shares, the traditional price to earnings ratio is often used. This ratio is the result of dividing a company's share price by its earnings per share.
However, analysts don't tend to use this method for banks. There are a number of reasons for this, with one being the fact that a bank's earnings ignore the significant value sitting on its balance sheet.
Instead, analysts may prefer to use a price to book ratio when analysing bank shares. Similar to the price to earnings ratio, this ratio divides the company's share price by the book value per share. The lower the ratio compared to its peers the better.
But even that is too simplistic for many analysts.
How else can you value its shares?
Fortunately, the team at Goldman Sachs have just valued the NAB share price and revealed their methods.
Goldman Sachs has a conviction buy rating and $30.34 price target on NAB's shares at present. This is based on a 50:50 blend of its discounted cash flow and return on equity versus price to net tangible assets (NTA) valuation. This is far more complex than the above methods, but I will try and take you through it now.
Equity value per share:
- Goldman estimates NAB's future cash flows at $70,031 million based on a 10.7% discount rate.
- Estimated value of future franking credits $15,282 million.
- Total equity value $85,313 million.
- 3,201 million shares.
- Equity value per share of $26.66.
This is then blended evenly with its NTA estimates versus its sustainable return on tangible equity estimate (ROTE) of $34.01 to give us a final valuation of $30.34.
The good news is that this compares favourably to the current NAB share price of $26.34. This implies potential upside of 15.2% over the next 12 months before dividends.
Foolish Takeaway
While Goldman's valuation model will go over the heads of many readers, the key takeaway is that it demonstrates why a price to earnings ratio can be too simple if you want to effectively value the NAB share price.
