With the Bank of Queensland Limited (ASX: BOQ) currently trading around $ 8.91, let’s review two common stock pricing tools that an analyst could use to provide their “ target ” on an ASX bank stock like BOQ.

As you may know, this is the “easy” or “simple” version. But “easy” does not necessarily equate to “good”. So, at the bottom of this article, we’ll provide additional resources to complement our potential indicative assessments. Basically, it goes without saying, but these valuations are not guaranteed.

Bank shares like Bank of Queensland Limited, Bendigo & Adelaide Bank Ltd (ASX: BEN) and Westpac Banking Corp (ASX: WBC) are very popular in Australia because they tend to have a stable dividend history and often pay postage credits.

In this article, we will explain the basics of investing in ASX bank stocks. But if you want to understand the value of dividend investing in Australia (i.e. the benefits of postage credits), check out this video from the Rask Australia teaching team.

To access our valuation models, videos and tutorials, please subscribe to the Rask Australia YouTube Channel. You will receive the latest (and free) value investing videos from our analysts. Click here to subscribe.

Ratio analysis

If you’ve been investing in direct stocks for more than a few years, you will have heard of the PE ratio. The price-to-earnings ratio or “PER” compares a company’s stock price (P) to its most recent earnings per share for a full year (E). If you bought a cafe for $ 100,000 and it made a profit of $ 10,000 last year, that’s a price-earnings ratio of 10x ($ 100,000 / $ 10,000). “Gains” is just another word for profit. Thus, the PE ratio essentially says “multiple price / annual profit”.

The PE ratio is a very simple tool but it is not perfect, so it should only be used with other techniques (see below) to back it up. That said, one of the simple ratio strategies that even professional analysts will use to value a stock is to compare the company’s PE ratio with its competitors to try to determine if the stock is overvalued or undervalued. This amounts to saying: “if all other stocks in the banking sector are valued at a PE of X, this should be too”. We will go further than that in this article. We will apply the mean reversion principle and multiply earnings per share (E) by the industry average PE ratio (E x industry PE) to calculate what an average company would be worth.

If we take the BOQ stock price today, along with the earnings (i.e. earnings) per share data for its fiscal year 2020, we can calculate the company’s PE ratio at 17. , 4x. This compares to the average banking sector PE of 25x.

We can take earnings per share (EPS) ($ 0.511) and multiply it by the average BOQ valuation. This results in a valuation of the “adjusted by sector” share of $ 12.72.

Beyond BOQ’s dividend yield

A DDM or dividend discount model is quite different from ratio valuations like PER in that it allows you to forecast cash flow into the future (it uses dividends as “cash flow”). Since the banking sector has been shown to be relatively stable with regard to stock dividends, the DDM approach can be used. However, we would not use this model for, for example, technology shares.

Basically, we only need one entry in a DDM model: dividends per share. Next, we make some assumptions about the annual dividend growth (eg 2%) and the risk level of the dividend payment (eg 7%). We used the most recent annual dividends (for example, from the last 12 months or LTM) then assumed dividends remain constant but increase slightly.

Suppose last year’s dividend payments are consistent over time. Please note that the use of dividends paid Last year is not always a good entry into a DDM since the future is what matters to us (note: we have made adjustments below to handle this).

To make DDM easy to understand, we will assume that the dividend payment increases at a constant rate in the future (i.e. forever) at a fixed annual rate.

Next, we need to choose a “risk” rate or an expected rate of return to discount future dividend payments in today’s dollars. The higher the “risk” rate, the lower the valuation of the share price.

We used an average dividend growth rate and a risk rate of between 6% and 11%.

This simple DDM valuation of BOQ shares is $ 2.29. However, using an “adjusted” dividend payment of $ 0.36 per share, the valuation jumps to $ 6.45. The valuation compares to the Bank of Queensland Limited share price of $ 8.91.

More research

Simple valuation models like these can be handy tools for analyzing and valuing a bank stock like Bank of Queensland Limited. And while these designs can even make you feel warm and fuzzy inside because you “ put a value on it. ”

That said, it’s far from a perfect assessment (as you can see). While no one can ever guarantee performance, there are things you can (and probably should) do to improve the assessment before you see it as a valid criterion.

For example, studying the growth or increase in total loans on the balance sheet is a very important thing to do: if they grow too fast, it means that the bank could take too much risk; too slow and the bank might be too conservative. Then study the rest of the financial statements for risks.

The areas to focus on are provisions for bad debts (income statement), their rules for valuing bad debts (accounting notes) and sources of capital (wholesale debt markets or customer deposits). On this last point, note how much it costs the bank to raise capital in its operations in order to lend to clients, bearing in mind that foreign debt markets are generally riskier than deposits from clients due to exchange rates, regulations and the volatile nature of the investment markets.