The notion that you are
better off owning the banks rather than lending money to them
through term deposits has proven correct over the last 12
Not only have we seen the cash rate fall to record low levels,
there has also been a rise in bank share prices along with a
healthy yield along the way. This chase for yield has pushed the
prices for the 'big four' banks to much higher values and
has led overseas commentators to report that our banks are not only
fully priced but that Commonwealth Bank is the most expensive bank
in the world "on every metric".
Shareholders who accepted Commonwealth Bank's share purchase
plan in 2009 at $26 would be extremely happy with the current share
price growing to near $80 a share.
Figure 14 shows a summary of bank valuations from 2011 to
demonstrate the change in yield, PE and price to book measures.
Each show that banks are less attractive now than in the preceding
2 to 3 years. Notably, yields dropping from around 7% to under 5%
and price to book ratios near or over 2 are not attractive for new
But where do we go from here?
Most portfolios are likely to be showing an overweight position
to the banks in general. Should profit be taken or should
shareholders accept the risk of an overweight position? Capital
gains tax is of course an issue to be considered. Generally, given
the heady valuations (refer to Figure 14 above), we would suggest
investors should be prudent and consider trimming an overweight
position. If something should happen to the bank prices it will
have a much greater impact on the overall portfolio. Of course,
there is then the dilemma of where to reinvest. Where only a single
bank is held, the others may be worth looking into, but it will be
undertaken on the same high valuation you should be wary of. Given
the still appealing yields, greater intra-sector diversification
can be beneficial whilst still maintaining the attractive bank
Although it may appear that our banks are invincible, we must
keep in mind that business cycles come and go and some companies
have finite lifetimes. No corporation is immune to mistakes and
this is why we recommend taking profits when they are available.
The major risk for the future of the banks is a recession, which
could lead to a rise in unemployment that leads to higher loan
defaults and hence bad debts. Although banks always have provisions
for bad debts, an increase will not only affect profitability but
undoubtedly dividends and therefore share prices. When holding onto
the banks or contemplating future purchases, you must consider why
you own them.
If it is for income, then the banks offer excellent dividends in
a range of around 5%-6% fully franked, which equates to around 7%
including the franking credit. If you own them for growth, then
they do appear to be fully priced.
So beware of buying them in
expectation of similar growth in share price that we have witnessed
over the last year – expectations should be for a more
In the years following the global financial crisis of 2008 many Australian investors lost their life savings as financial products failed and the Australian Stock Exchange shed over 3,000 points.
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