With the WBC share price trading around $26.09, are Westpac Banking Corp (ASX:WBC) shares today, tomorrow or next month is as good as a guess. However, over the longer term, shares with a consistent track record of profits, dividends and/or cash flow will often revert to their underlying intrinsic value.
Westpac is the second-largest ‘Big Four’ bank, and a financial services provider, headquartered in Sydney. Alongside CommBank, ANZ and NAB, Westpac finances homeowners, investors, individuals (via credit cards and personal loans) and businesses.
At $26, is the Westpac Banking Corp share price cheap?
What’s going on inside
For long-term investors looking to invest in great companies and hold them for five, 10 or 20 years, at Rask we think it’s fair to say that a good workplace and staff culture can lead to improved retention of high-quality personnel and, in turn, long-term financial success of a company.
One way Aussie investors can take a ‘look inside’ a company like Westpac Banking Corp or Bank of Queensland Limited is to use a HR/jobs websites such as Seek. Seek’s website includes data on the HR of companies, including things like employee reviews. According to the most recent data we pulled on WBC, for example, the company’s overall workplace culture rating of 3.4/5 was more than the ASX banking sector average rating of 3.23.
Watch those (net) margins
ASX bank shares such as WBC need debt and good profit margins to make their business profitable. Meaning, a bank gets money from term deposit holders and wholesale debt investors and lends that money to homeowners, businesses and investors. The difference between what a bank pays to savers and what it makes from mortgage holders (for example) is the net interest margin or NIM. Rememeber: when it comes to NIMs, the wider the margin the better.
If you are forecasting the profits of a bank like WBC or National Australia Bank Ltd (ASX:NAB), knowing how much money the bank lends and what it makes per dollar lent to borrowers is essential. That’s why the NIM is arguably the most important measure of WBC’s profitability. Across the ASX’s major bank shares, we calculated the average NIM to be 1.93% whereas Westpac Banking Corp bank’s lending margin was 1.9%, highlighting it delivered a lower-than-average return from lending compared to its peer group. This may happen many reasons, which are worth investigating.
The reason analysts study the NIM so closely is because Westpac Banking Corp earned 83% of its total income (akin to revenue) just from lending last year.
Return on shareholder equity (ROE)
Return on shareholder equity or just ‘ROE’ helps you compare the profit of a bank against its total shareholder equity, as shown on its balance sheet. The higher the ROE the better. Westpac Banking Corp’s ROE in the latest full year stood at 7.3%, meaning for every $100 of shareholder equity in the bank it produced $7.30 in yearly profit. This was more than the sector average of 6.99%.
WBC’s back-up bank capital
For Australia’s banks the CET1 ratio (aka ‘common equity tier one’) is paramount. CET1 represents the bank’s capital buffer which can go towards protecting it against financial collapse. According to our numbers, Westpac Banking Corp had a CET1 ratio of 11.1%. This was below the sector average.
WBC’s dividend valuation – a few tricks for bank stocks
A dividend discount model or DDM is one of the most efficient ways to value ASX bank shares. To do a DDM we have to estimate the bank’s dividends going forward (i.e. the next full-year dividend) and then apply a risk rating. Let’s assume the WBC’s dividend payment grows at a consistent rate each year into the future, somewhere between 2% and 3%. We will use multiple risk rates (between 6% and 11%) and then average the valuations.
According to this quick and simple DDM model, a valuation of WBC shares is $4.89. However, using an ‘adjusted’ dividend payment of $1.07 per share, which is the preferred measure because it uses future dividends, the valuation goes to $16.86. The valuation compares to WBC’s current share price of $26.09.
What this means is, although the WBC share price might seem expensive using our simple DDM model, don’t make a decision based on this article. Please go away now and consider all of the risks and ideas we presented here, including the benefit of faster growing dividends and the positive impact of franking credits. Consider getting our free investment report emailed to you (keep reading).
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