Bigger yields from the big 4?

Bank stocks are trading at historically high P/E ratios — does a boost in yield make them worth another look?

Andrew Mudie

Andrew joined the growing team of Motley Fool freelance writers in mid-2013 following years of personal development as a passionate self-taught sharemarket investor. At the time, Andrew was an engineer by trade, writer by hobby, and an investing nerd by passion who spent far too many breaks reading, writing and learning. Andrew’s first investing lesson came with his first stock selection in 2011 when takeover rumours caused a spike and subsequent plunge in the share price of Woodside and then the 21% fall in the market through mid-2011. The next four years of investing saw Andrew dabble in a vast array of strategies until settling on his favourite investment methodology, which is closely aligned with that of the Motley Fool: Fundamentals-based long-term buy-and-hold of great companies at great prices.

Published October 21, 2013 7:00 am AEDT

Between 29 October and 4 November, three of Australia's big four banks are due to report their earnings for the financial year ending 30 September. ANZ (ASX: ANZ) will report first on 29 October, followed by NAB (ASX: NAB) on 31 October, and Westpac (ASX: WBC) on November 4.

The banking sector has outperformed by ASX 200 index by 1.5% since 30 June, and by around 15% since the beginning of the year. The general consensus is that the price gains have been due to low-yielding term deposit funds shifting into the high, sustainable yield paid by the big banks.

A few of the major broking houses have crunched the numbers on the banks, and most are expecting high single-digit earnings per share growth for the financial year. The expectation is that this will allow the banks to increase dividends, as ongoing low interest rates have reduced the risk of bad corporate and residential debts.

ANZ is expected to deliver cash profits of over $6.4 billion, representing a rise of around 7% on last year's numbers. This should allow the bank to increase dividends by 13 cents, from 145 cents to 158 cents, a rise of nearly 9%. Meanwhile, NAB is expected to grow profits by over 10% to over $6 billion, and push up dividends by 6% from 180 cents to 191 cents. Finally, Westpac is predicted to boost earnings and dividends by 8% to over $7.1 billion and 180 cents respectively.

The estimates put the 2014 dividend yields at 5.4% (ANZ), 6% (NAB), and 6% (WBC).

Foolish takeaway

The big four banks have significant competitive advantages over their local peers, with greater pricing power due to their size. All four have strong balance sheets, high profitability, solid credit ratings and excellent risk management. Switching costs and the network effect of having multiple services with one bank (i.e., credit card, mortgage and everyday savings account) is an additional advantage.

Having said that, the 50% return from the banks in the last 18 months has pushed the price-to-earnings ratio to historically high levels. Investors should look at economic indicators for signs of increased borrowing to be sure that earnings will rise in the future to catch up to the share price growth.

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Motley Fool contributor Andrew Mudie does not own shares in any of the companies mentioned.

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