Wouldn’t it be handy to know how an analyst rates ASX bank stocks as ANZ Banking Group (ASX: ANZ) actions? With the ANZ stock price around $ 28, is it cheap?
No one can tell you for sure if this is the best time to buy.
In the short term, the stock market can seem like a hit or miss place. It can increase by 2% one day, decrease by 3% the next day. There is often no rhyme or reason (although the experts get paid dearly for the evening news to make you think they have a crystal ball).
In this article, we will go step by step through two simple assessment tools that you can use to assess a stock like ANZ or even National Australia Bank Ltd (ASX: NAB) and Commonwealth of Australia Bank (ASX: ABC).
PE ratio analysis
Price-to-earnings ratio, which is short for price-to-earnings, is a basic but popular valuation ratio. It compares the annual profit (or “profit”) to today’s stock price ($ 27.7). Unfortunately, it’s not the perfect tool for bank stocks, so it’s important to use more than PE ratios for your analysis.
That said, it can be useful to compare PE ratios between stocks in the same industry (bank) and determine what is reasonable and what is not.
If we take the ANZ stock price today ($ 27.7), along with its fiscal 2020 earnings (or earnings) per share data ($ 1.21), we can calculate the PE ratio. of the company at 22.9x. This compares to the average banking sector PE of 24x.
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 $ 29.61.
Why dividends matter to ANZ investors
A DDM is a more interesting and robust way to assess companies in the banking industry, since the dividends are quite consistent.
DDM valuation modeling is one of the oldest methods used on Wall Street for valuing companies, and it is still used here in Australia by bank analysts. A DDM model takes the most recent full-year dividends (e.g. last 12 months or LTM), or expected dividends, for next year, then assumes dividends grow at a constant rate for a forecast period (e.g. 5 years or forever).
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 $ 27.70. 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 ($ 1.74), our valuation of the ANZ stock price is estimated at $ 31.24.
Is this ANZ valuation reasonable?
Remember that the two models used here are just the starting point in the process of analyzing and valuing a bank stock like ANZ.
We think it’s good practice to read at least three years of annual reports, write down your thoughts / research, and set out your thesis / expectations based on what management is saying. Indeed, a very useful tool is the study of management language in presentations and videos. Is the management team sincere? Or does he use a lot of jargon and never answer a direct question? Finally, read articles and research from good analysts, and when you do, look for people who disagree with you. These voices are often the most informative.
These are just a few of the best strategies to use with your assessment tools to determine if you are making a mistake – hopefully before you make a costly mistake!