Make no mistake Westpac Banking Corp (ASX: WBC) is a great bank… but its shares are not a good buy today.
Along with its big four peers – Commonwealth Bank of Australia (ASX: CBA), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd (ASX: NAB) – Westpac shares are currently at eye-watering valuations.
Even so, that's not the only reason why I sound like a broken record when it comes to the big banks – I've been saying they're overvalued for a while now.
The real reason I'm avoiding Westpac shares right now, can be put down to an array of troubling signals which are telling investors to wait for the next bear market – believe me, they usually come sooner than you'd expect!
Firstly, the long-term average price-earnings (P/E) ratio of Australia's big banks is around 12. For Westpac, currently $37.50, that'd mean a share price of $29.55 based on last year's earnings.
But there are three big problems with trying to value the banks that way:
- Share prices change
- Earnings per share change
- P/E ratios shouldn't be used to value banks
Last year's earnings per share, or EPS, were boosted by falling bad debts as the banks likely entered the 'sweet spot' of their market cycle.
So the 'average' profits I used to calculate that $29.55 share price figure above, is also being boosted by the leveraged cyclicality of banks' profits. Using the EPS average of the past three years, gives a mean share price closer to $27 – a hefty 28% discount to today's price.
It's also important to remember Australia has gone over two decades without a recession and enjoyed a property and mining boom. The latter of which has ended.
Earnings growth for the big banks in the future will be harder to come by. This will place more pressure on margins and further erode profitability.
Finally, my preferred ratio for valuing bank stocks is the price to tangible book value (PTBV) ratio. Put simply, it relates price to the value of all the loans and other 'assets' on a bank's balance sheet and excludes intangible items like goodwill – which the bank doesn't make money from.
Westpac's PTBV is over 3.2 times, that's an alarmingly high number for a stock which is potentially entering a period of lower growth, more regulation and has an assets (i.e. loans) to equity ratio of over 15.6.
But instead of taking my word for it, here's what Commbank CEO Ian Narev said in his bank's recent results announcement: "The volatility of the global economy continues to undermine confidence, particularly the impact of lower commodity prices on national revenue… Weak confidence is a significant economic threat. Businesses need the certainty to invest to create jobs, and households need a greater feeling of security."
Perhaps unsurprisingly, Mr Narev sold $750,000 worth of Commbank shares a few days later.
Foolish takeaway
If you're in the market for dividends, don't carelessly buy the big banks, Telstra Corporation Ltd (ASX: TLS) or miners because of their familiarity or track records. And if your broker or advisor is telling you to buy them – and you seriously want to create long-term wealth for you and your family – either:
- Run for the hills, or
- Ask them what they make of the above (remember: brokers are usually rewarded for transactional value – it's pretty easy to get a client to jump on the big banks in a low interest rate environment)
Share market investing is a long-term pursuit. Low interest rates won't be here forever, Westpac shares won't be expensive forever and patience doesn't lose you money.
