ASX 200 Bank Shares: Westpac Banking Corp (ASX: WBC) share price
With the Westpac banking company (ASX: WBC) currently trading around $ 26, let’s review two standard stock price valuation tools that an analyst could use to provide their analyst valuation on an ASX bank stock like WBC.
As you may know, this is the standard version. Keep in mind that standard does not necessarily mean “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 stocks like Westpac Banking Corp, Bank of Queensland Limited (ASX: BOQ) and National Australia Bank Ltd (ASX: NAB) 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 investing in dividends in Australia (i.e. the benefits of postage credits), check out this video from the education team at Rask Australia.
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Choose an EP
If you’ve been investing in individual stocks or companies for more than a few years, you’ve heard of the PE ratio. The price-to-earnings ratio or “PER” compares a company’s share price (P) to its most recent annual earnings per share (E). If you bought a cafe for $ 100,000 and it made $ 10,000 in profit last year, that’s a 10 times price-earnings ratio ($ 100,000 / $ 10,000). “Earnings” is just another word for profit. Thus, the PE ratio essentially says “multiple price / annual earnings”.
The PE ratio is a very basic 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 basic 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 perfectly valued. . This amounts to saying: “if all the other stocks in the banking sector are listed at a PE of X, this one should be too”. We will go further than that in this article. We will apply the reversion principle to the average and multiply earnings per share (E) by the industry average PE ratio (E x sector PE) to calculate what an average company would be worth.
If we take WBC’s stock price today ($ 25.96), along with its fiscal 2020 earnings (or earnings) per share data ($ 0.637), we can calculate the PE ratio of l business at 40.8x. This compares to the average banking sector PE of 25x.
Then take the earnings per share (EPS) ($ 0.637) and multiply it by the average PE ratio of the WBC (Banking) industry. This translates to an “sector adjusted” PE valuation of $ 15.76.
WBC DDM valuation
A DDM or dividend discount model is quite different from ratio valuations like PER in that it allows you to forecast future cash flows (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 wouldn’t use this model for, say, tech stocks.
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 full year dividends (e.g. last 12 months or LTM) then assumed dividends remain constant but increase slightly.
To make this DDM easy to understand, we’ll assume that last year’s dividend payment ($ 0.31) increases at a constant rate in the future at a fixed annual rate.
Then we choose the “risk” rate or the expected rate of return. This is the rate at which we 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 rate for dividend growth and a risk rate of between 6% and 11%.
This simple DDM valuation of WBC shares is $ 5.91. However, using an “adjusted” dividend payment of $ 1.07 per share, the valuation drops to $ 19.18. The expected dividend valuation compares to the Westpac Banking Corp share price of $ 25.96. Since the company’s dividends are fully franked, you can choose to make an additional adjustment and valuation on the basis of a “gross” dividend payment. That is, cash dividends plus postage credits (available to eligible shareholders). Using the expected gross dividend payout ($ 1.53), our assessment of the projection of the WBC share price at $ 27.40.
Don’t stop here
Simple valuation models like these can be handy tools for analyzing and valuing a bank stock like Westpac Banking Corp.
That said, it’s far from a perfect valuation (as you can see). While no one can ever guarantee a return, there are things you can (and probably should) do to improve valuation before you see it as a valid yardstick.
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.
Areas to focus on include provisions for bad debts (income statement), their bad debt valuation rules (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 business to lend to customers, keeping in mind that overseas debt markets are generally riskier than customer deposits. due to exchange rates, regulations and the volatile nature of investment markets.