With the ANZ Banking Group (ASX: ANZ) currently trading around $ 29, let’s go over two standard stock price valuation tools that an analyst could use to provide their intrinsic valuation on an ASX bank stock like ANZ.
As you may know, this is the general version. Keep in mind that general 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 ANZ Banking Group, National Australia Bank Ltd (ASX: NAB) and Commonwealth of Australia Bank (ASX: CBA) 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 (free) videos on investing in value from our analysts. Click here to subscribe.
PE ratio analysis
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 earnings per share for the entire year (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 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 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 excessive or priced perfectly. . 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 the 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 ANZ’s stock price today ($ 28.71), along with its fiscal 2020 earnings (or earnings) per share data ($ 1.21), we can calculate the PE ratio. of the company at 23.7x. This compares to the average banking sector PE of 26x.
Next, take earnings per share (EPS) ($ 1.21) and multiply it by ANZ’s industry average PE ratio (Banking). This translates to an “sector adjusted” PE valuation of $ 30.97.
Why dividends matter to ANZ investors
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 (for example from the 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 ($ 0.60) 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 ANZ shares is $ 11.44. However, using an “adjusted” dividend payment of $ 1.22 per share, the valuation drops to $ 21.87. The expected dividend valuation compares to the ANZ Banking Group share price of $ 28.71. 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. In other words, cash dividends plus postage credits (available to eligible shareholders). Using the expected gross dividend payout ($ 1.74), our assessment of the projection of the ANZ stock price at $ 31.24.
Is this ANZ valuation reasonable?
Simple valuation models like these can be handy tools for analyzing and valuing a bank stock like ANZ Banking Group. And while these designs can even make you feel warm and hazy in the interior because you “put value” on it.
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 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 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.