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This is how to work out the best value ASX bank stock

Brendon Lau
a hand drawing a balancing scale in which price outweighs value

Make no mistake – there’s only one reason why you would buy an ASX bank stock and it’s not for the housing market recovery.

While property auctions rates are moving from strength-to-strength, leading experts to declare that house prices are on the path to recovery, the same can’t be said for bank profits.

Understanding what will drive investors to buy bank shares will help you work out if the Commonwealth Bank of Australia (ASX: CBA) share price, Westpac Banking Corp (ASX: WBC) share price, Australia and New Zealand Banking Group (ASX: ANZ) share price or National Australia Bank Ltd. (ASX: NAB) share price offers the best value.   

Housing bounce won’t necessarily mean higher profits

But before we get into that, it’s important to know why the housing market recovery won’t lead to higher profits for the banks, even though the opposite was true – that when the residential market was in a correction, bank profit suffered.

Two things have changed since. The first is falling interest rates as pressure mounts on banks to lower mortgage rates by similar amounts as the Reserve Bank of Australia’s interest rate cut. The big four haven’t passed on the last two rate cuts in full but they have mostly done that, much to the detriment of their margin as their borrowing costs haven’t fallen by quite as much.

This is unlikely to change, so even as demand for loans rebound, that will only really help their top-line and not their bottom-line.

The second issue is that our big four are increasingly losing market share to new non-bank lenders. This leaves borrowers with the pricing power, not the big banks.

The most expensive ASX bank may be the cheapest

So, if you think you should buy the banks for profit growth, think again! The only real reason to buy the big four is for their juicy fully-franked dividends as yield is increasingly difficult to find in the current economic climate.

This means valuing am ASX bank stock really means working out if it can sustain its current dividend payment (hoping for increasing dividends is too much!) despite the challenging operating environment.

I am not saying other well used valuation metrics like price-earnings (P/E), and return on equity (ROE) are suddenly irrelevant, but I believe these ratios should take a backseat in the current environment.

If you ascribe to this view, as I do, the most expensive ASX big bank stock, which is CBA, is looking like one of the best value on the market.

This is because there’s a high level of confidence that it can keep paying an annual dividend of $4.31 per share, which puts its yield at 5.2%, or 7.5% if franking is included.

Analysts have also expressed confidence that ANZ Bank can sustain its $1.60 per share payout as well, which would give the stock a yield of 8.3% with franking. That technically means it’s better value than CBA but I have three issues with ANZ.

Firstly, it has a Kiwi problem. The Reserve Bank of New Zealand (RBNZ) is going after the bank for breaking the rules. Secondly, RBNZ is thinking about getting the big four Aussie banks to significantly lift their capital adequacy buffer and that will mean lower profits for the sector. Guess which bank is most exposed to this risk?

The third problem is that ANZ seems to be losing the most market share of mortgages among the big four.

Why NAB and Westpac are in last place

Technically, NAB’s dividend is safe too as it has already cut the amount it pays shareholders but I am usually nervous when a new CEO is installed in any beleaguered listed company. I suspect the bank’s new boss Ross McEwan will want to clear the decks as he charts a new course for NAB (and tries to change the foul culture of the bank) – and that may mean bad news like write-downs.

This doesn’t mean its dividend is at risk, but I am happy to give up a few percentage points of yield to not worry about this risk.

As for Westpac, I think the bank’s dividend is the most vulnerable of the four and I am bracing for some bad dividend news later this year.

I wouldn’t touch the regional banks as I think they are suffering the most in a falling interest rate environment due to their larger dependence on depositors to fund their lending book.

But as with anything, diversification is key. If you want to build a relatively dependable income portfolio, you can’t just load up on one or two stocks. This means I wouldn’t just be buying CBA and ANZ shares.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, Commonwealth Bank of Australia, and Westpac Banking. Connect with him on Twitter @brenlau.

The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

The Motley Fool's purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. 2019