Thinking of investing in National Australia Bank Ltd (ASX: NAB) shares, or a competitor like Westpac Banking Corp (ASX: WBC)? With the NAB share price trading at $27.72, now is a great time to take a closer look.
NAB is one of Australia’s four largest banks in terms of market capitalisation, profits and customers. As of 2020, NAB was also one of Australia’s largest lenders to businesses, but it also has operations in residential lending. NAB operates the online-only Ubank.
NAB share price: time to buy?
1. Assessing management & the workplace
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 National Australia Bank Ltd or Westpac Banking Corp 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 NAB, for example, the company’s overall workplace culture rating of 3.2/5 was not as much as the sector average of 3.23.
2. Look at the banking margins
ASX bank shares such as NAB 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. Remember: when it comes to NIMs, the wider the margin the better.
If you are plan to forecast the profits of a bank like NAB or ANZ Banking Group (ASX: ANZ), knowing how much money the bank lends and what it makes per dollar lent to borrowers is crucial. That’s why the NIM is arguably the most essential measure of NAB’s profitability. Across the ASX’s major bank shares, we calculated the average NIM to be 1.92% whereas National Australia Bank Ltd bank’s lending margin was 1.77%, 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 National Australia Bank Ltd earned 80% of its total income (akin to revenue) just from lending last year.
3. What’s the 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. National Australia Bank Ltd’s ROE in the latest full year stood at 6.%, meaning for every $100 of shareholder equity in the bank it produced $6.00 in yearly profit. This was less than the sector average of 7.46%.
4. The buffer against losses
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, National Australia Bank Ltd had a CET1 ratio of 11.4%. This was less than the sector average.
5. Putting a rough valuation on NAB shares
A dividend discount model or DDM is one of the most efficient ways to create a prediction 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 NAB’s dividend payment rises 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 NAB shares is $10.20. However, using an ‘adjusted’ or expected dividend payment of $1.12 per share, which is the preferred measure because it uses forecast dividends, the valuation goes to $19.03. The valuation compares to NAB’s current share price of $27.72. 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 to $27.19.
What this means is, although the NAB 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 growing dividends and the strong impact of franking credits. Consider getting our free investment report emailed to you (keep reading).