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You can value the ANZ share price using dividend yield, here’s how

The ANZ Banking Group (ASX: ANZ) share price is up 22% since the start of the year. Is the ANZ share price undervalued?

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Knowing what is or isn’t a fair price to pay for the ANZ Banking Group (ASX: ANZ) share price can seem a little daunting, especially in the current volatility. In this short news update on the ANZ share price, we’ll look at the key factors to consider when researching a bank share.

ANZ Bank is a leading bank in Australia and New Zealand, with a presence throughout the oceanic region. ANZ is one of the Big Four Aussie banks and a leader in the NZ banking market, deriving much of its revenue from mortgages, personal loans and credit.

ANZ share price

Researching ANZ Banking Group’s culture

For long-term investors looking to invest in great companies and hold them for 5, 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 get under the hood of a company like ANZ Banking Group or National Australia Bank Ltd is to use a HR/jobs websites such as Seek. Seek’s website includes data on the culture of companies, including things like employee reviews. According to the most recent data we pulled on ANZ, for example, the company’s overall workplace culture rating of 3.3/5 was greater than the ASX banking sector average rating of 3.13.

ANZ’s lending standards

ASX bank shares such as ANZ need deposits 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. Remember: when it comes to NIMs, the wider the margin the better.

If you are planning to forecast the profits of a bank like ANZ or Commonwealth Bank of Australia (ASX: CBA), knowing how much money the bank lends and what it makes per dollar lent to borrowers is important. That’s why the NIM is arguably the most essential measure of ANZ’s profitability. Across the ASX’s major bank shares, we calculated the average NIM to be 1.92% whereas ANZ Banking Group bank’s lending margin was 1.63%, highlighting it delivered a lower-than-average return from lending compared to its peer group. This may happen for many reasons, which are worth investigating.

The reason analysts study the NIM so closely is because ANZ Banking Group earned 80% of its total income (akin to revenue) just from lending last year.

ROE

Return on shareholder equity, also known as ‘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. ANZ Banking Group’s ROE in the latest full year stood at 10.9%, meaning for every $100 of shareholder equity in the bank it produced $10.90 in yearly profit. This was greater than the sector average of 10.43%.

ANZ’s capital structure

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 – basically, it’s the proportion of total assets that are ‘liquid’ or readily available. According to our numbers, ANZ Banking Group had a CET1 ratio of 13.3%. This was more than the sector average.

Dividends & valuation for banks like ANZ or CBA

A dividend discount model or DDM is one of the most efficient ways to create an estimate of ASX bank shares. To do a DDM we have to arrive at a forecast of the bank’s dividends going forward (i.e. the next full-year dividend) and then apply a risk rating. Let’s assume the ANZ dividend payment increases at a consistent rate each year into the future, somewhere between 2% and 4%. We will use multiple risk rates (between 6% and 11%) and then average the valuations.The calculation we use is Share price = full-year dividend / (risk rate – dividend growth rate).

According to this quick and simple DDM model, an estimated valuation of ANZ shares is $29.74. However, using an ‘adjusted’ or expected dividend payment of $1.66 per share, which is the preferred measure because it uses forecast dividends, the valuation goes to $28.21. The valuation compares to ANZ’s current share price of $31.79. Since the company’s dividends are fully franked, we can make a further adjustment and do a valuation based on a ‘gross’ dividend payment. Using gross dividend payments, which take into account franking credits, the valuation forecast becomes $40.30.

What this means is that the ANZ share price might seem expensive using our simple DDM model, but this is just one of many steps you should take before making an investment decision. It’s important to consider all of the risks and ideas we presented here, including the benefit of growing dividends and the solid impact of franking credits. To learn more about analysis and valuation, consider getting our free investment report emailed to you (keep reading).

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