The Westpac Banking Corp (ASX: WBC) share price has seen plenty of volatility since the start of the COVID-19 pandemic. But, at the current valuation, the ASX bank share looks like a leading contender.
There is a lot of competition in the banking space, including Commonwealth Bank of Australia (ASX: CBA), ANZ Group Holdings Ltd (ASX: ANZ), National Australia Bank Ltd (ASX: NAB), Bank of Queensland Limited (ASX: BOQ) and Bendigo and Adelaide Bank Ltd (ASX: BEN).
The last 12 months have been an interesting time for the banking sector with how interest rates have rapidly shot higher.
ASX bank shares like Westpac have come under pressure for passing on interest rate hikes quickly to borrowers, but not being as generous to savers.
In the current environment, I think there are a couple of key reasons why the Westpac share price looks cheap:
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Low price/earnings ratio
The bank has a very low price/earnings (P/E) ratio. What that means is that it's trading at a low multiple of its earnings.
While an extremely low P/E ratio isn't necessarily what investors need to find, it can be helpful to find ones that are at good value, and hopefully buying a lower P/E ratio for that same business is usually helpful.
According to Commsec, Westpac could generate $2.04 of earnings per share (EPS). At the current Westpac share price, that puts the forward P/E ratio at 11 times FY23's estimated earnings.
That seems relatively cheap, particularly when compared to a peer like CBA which is currently trading at 17 times FY23's estimated earnings, a significantly more expensive valuation.
The lower P/E ratio also has a pleasing bonus – the dividend yield is particularly high. Commsec numbers suggest that the Westpac dividend per share could be $1.38, with a grossed-up dividend yield of 8.6%.
Rapidly increasing return on equity (ROE)
One of the biggest bits of help for Westpac could be the improvement in profitability thanks to the higher lending profits. This can help the Westpac share price as well.
An increasing return on equity (ROE) can make the business a lot cheaper.
My colleague James Mickleboro recently reported on comments from Morgans about the compelling situation for Westpac:
We view WBC as having the greatest potential for return on equity improvement amongst the major banks if its business transformation initiatives prove successful. The sources of this improvement include improved loan origination and processing capability, cost reductions (including from divestments and cost-out), rapid leverage to higher rates environment, and reduced regulatory credit risk intensity of non-home loan book. Yield including franking is attractive for income-oriented investors, while the ROE improvement should deliver share price growth.
Westpac share price snapshot
Despite the interest rate environment looking more favourable for bank profitability, the Westpac share price is down 3% over the past year.
