Are bank shares back into buying territory?

Are bank shares back into buy territory?

Yields are back above 8.5% for 2014.

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 February 10, 2014 4:00 am AEDT

Since the beginning of the year Australia's big four banks have experienced a mini correction along with the broader market. The ASX 200 fell just over 5% between the 1 January and 5 February, before two strong days to close out last week pushed the 2014 loss back to 3.47%.

Interestingly, the big four banks all fell more than the broader index and the majority now have an estimated 2014 grossed up dividend yield above 8.5%. The table below shows the decline in share price between the 1 January and 5 February and the estimated dividend yield for 2014.

Company	Ticker	Share Price Decline	2014e Dividend Yield	Grossed Up Yield
Australia and New Zealand Banking Group	ASX: ANZ	-9.1%	6.0%	8.5%
Commonwealth Bank of Australia	ASX: CBA	-5.8%	5.3%	7.6%
National Australia Bank Ltd.	ASX: NAB	-6.6%	6.3%	9.0%
Westpac Banking Corp	ASX: WBC	-5.1%	6.0%	8.6%
Term Deposit Rate			<3%	<3%

As can be seen, for investors relying on income, the grossed up dividend yield (which accounts for the tax incentives of franking credits) is well above the average term deposit rate, which dipped below 3% in January. With inflation hitting 2.7% in last month's reading, investors holding term deposits may be receiving at best 0.3% real return and at worst a negative real return on their investment.

This situation doesn't seem like it will change any time soon as the Reserve Bank of Australia signalled its intention to keep interest rates at their current 2.5% level for the foreseeable future. Additionally, in the current environment of slow mortgage growth, the big banks can afford to pay lower term deposit rates as their capital requirements aren't growing rapidly.

Foolish takeaway

Bell Potter's Charlie Aitken is similarly bullish on bank shares on the basis that while shares are inherently more risky than term deposits, the 'risk premium' (i.e the difference between grossed up yield and term deposit yields) is higher than it should be based on the stability of bank earnings. I tend to agree and believe that bank shares will continue to be supported in 2014 by buying from SMSFs and retirees searching for income.

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