National Australia Bank Ltd. (ASX: NAB) shares look cheap.
| NAB | Peer-group average | |
| Price-Earnings Ratio (P/E)(times) | 11x | 12x |
| Dividend Yield (%) (fully franked) | 7.4% | 6.8% |
| Price-Earnings-Growth (PEG) | 1.9x | 2.7x |
As can seen from the table above, shares of NAB appear good value relative to its peers, which include Westpac Banking Corp (ASX: WBC), Commonwealth Bank of Australia (ASX: CBA), Australia and New Zealand Banking Group (ASX: ANZ), and smaller regional players.
Is NAB ridiculously cheap?
It's important to consider what goes into these numbers before drawing any conclusions about NAB's value.
NAB has a lower (better) price-earnings ratio (P/E) than its peers. However, the P/E is an unreliable indicator of value, especially for intensely cyclical businesses, such as banks.
The market or S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) currently boasts an average P/E of 16.5x.
The price-earnings growth ratio (PEG) factors in forecasts for next year's profits. It is arguably a more reliable measure of value. Analysts prefer a lower PEG ratio to a higher PEG. With a ratio of 1.9x, NAB's shares appear better value than its peers when we factor in earnings per share forecasts.
Finally, dividend yield is a crude measure for most shares (dividends are optional — management isn't compelled to pay them every year), but it is arguably a robust valuation measure to benchmark established companies over a cycle. And at the end of the day, few investors would complain if NAB could only pay its enormous dividend four out of every five years. At 7.4% — fully franked — NAB's dividend yield is a compelling feature for income-starved portfolios.
Cheap or ridiculously cheap?
Using a dividend discount model (DDM) to value NAB shares in absolute terms a value of around $28 does not appear excessive. That implies a 4% margin of safety (the difference between estimated value and market price).
In my opinion, NAB shares are not 'ridiculously' cheap at today's level, just cheap relative to peers and the market. Therefore, NAB shares are not a standout buy. Investors should wait for a more compelling entry point.
