With the WBC share price around $31 here are a few techniques to value it

Right now, you could probably use Google or another data provider to see the price of Westpac Banking Corp (ASX: WBC) is around $31 per share. But what are WBC shares really worth?

Getting to an target valuation is one of the more popular questions or topics our senior investment analysts get asked by Australian investors, especially those seeking dividend income. It’s not exclusive to Westpac Banking Corp, of course.

Bank of Queensland Limited (ASX: BOQ) and National Australia Bank Ltd (ASX: NAB) are also very popular bank shares on the ASX.

Before we walk through two valuation models you might use to answer the question yourself, let’s consider why investors like bank shares in the first place.

Alongside the tech and industrial sectors, the financials/banking industry is a favourite for Australian investors. The largest banks, including Commonwealth Bank of Australia and National Australia Bank operate in an ‘oligopoly’.

And while large international banks, such as HSBC, have tried to encroach on our ‘Big Four’, the success of foreign competitors has been very limited. In Australia, ASX bank shares are particularly favoured by dividend investors looking for franking credits.

WBC share price: valuation in action

The price-earnings ratio, or PE ratio for short, is a basic but popular valuation ratio. It compares yearly profit (or ‘earnings’) to today’s share price (in the case of WBC for example, $30.65). It’s not always the best way to value a mature company like a bank because other factors may be more important, like dividends, so it’s vital to use more than just PE ratios for your analysis.

That said, it can be handy to compare PE ratios across shares from the same sector (banking) to determine what is reasonable — and what isn’t. For example, if WBC had a PE ratio twice as high as NAB, you’d have to ask yourself if there’s any good reason it should be worth more.

If we take the WBC share price today ($30.65), together with the earnings (aka profits) per share data from its 2023 financial year ($1.95), we can calculate the company’s PE ratio to be 15.7x. That compares to the banking sector average PE of 16x.

Next, take the profits per share (EPS) ($1.95) and multiply it by the average PE ratio for WBC’s sector (Banking). This results in a ‘sector-adjusted’ PE valuation of $31.23.

What are WBC’s dividends worth to an investor?

A DDM, which stands for Dividend Discount Model, is a more interesting and robust way of valuing companies in the banking sector, given that the dividends are pretty consistent.

DDM valuation modeling is one of the oldest methods used on Wall Street to value companies, and it’s still used here in Australia by bank analysts. A DDM model takes the most recent full year dividends (e.g. from last 12 months or LTM), or forecast dividends for next year, and then assumes the dividends grow at a consistent rate for a forecast period (e.g. 5 years or forever). The only other number you need is a ‘risk’ rate (e.g. 7%) which is explained further below.

To do the valuation, use this formula: Share price = full-year dividend / (risk rate – dividend growth rate). It’s a good idea to do the calculation with a few different growth and risk assumptions, then take the average valuation. This helps to account for some of the uncertainty.

To make this DDM easy to understand, we will assume last year’s dividend payment ($1.42) goes up at a fixed rate each year.

Next, we pick the ‘risk’ rate or expected return rate. This is the rate at which we discount the future dividend payments back to today’s dollars. The higher the ‘risk’ rate, the lower the share price valuation.

We’ve used a blended rate for dividend growth and a risk rate between 6% and 11%, then got the average.

This simple DDM valuation of WBC shares is $30.03. However, using an ‘adjusted’ dividend payment of $1.68 per share, the valuation goes to $30.11. The expected dividend valuation compares to Westpac Banking Corp’s share price of $30.65. Since the company’s dividends are fully franked, you might choose to make one further adjustment and do the valuation based on a ‘gross’ dividend payment. That is, the cash dividends plus the franking credits (available to eligible shareholders). Using the forecast gross dividend payment ($2.40), our valuation of the WBC share price guesstimate to $43.02.

WBC share price summary

Please be mindful that these valuation methods are just the starting point of the research and valuation process. Please remember that. Banks are very complex companies and if the GFC of 2008/2009 taught investors anything, it’s that even the ‘best’ banks can go out of business and take shareholders down with them.

If you are looking at Westpac Banking Corp shares and considering an investment, take your time to learn more about the bank’s growth strategy. For example, is it pursuing more lending (i.e. interest income) or more non-interest income (fees from financial advice, investment management, etc.)? Then, take a close look at economic indicators such as unemployment, house prices and consumer sentiment. Finally, it’s always vital to make an assessment of the management team.