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Here’s how I’d dig into the Westpac Banking Corp (ASX:WBC) share price

With the WBC share price trading arond $23.44 today, it’s worth asking if Westpac Banking Corp (ASX: WBC) shares are in the money. In this article we’ll take a look at the research process for shares of companies like WBC or Bank of Queensland Limited (ASX: BOQ) from the ground-up.

Westpac is the second-largest Big Four Australian bank. Headquartered in Sydney, Westpac’s primary role in the Aussie financial system is financing homeowners, investors and individuals (via credit cards and personal loans). It also has operations servicing business customers.

Here’s how I’d dig into the Westpac Banking Corp (ASX:WBC) share price

Tricks to analyse culture at Westpac Banking Corp

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 Westpac Banking Corp or Bank of Queensland Limited 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 WBC, for example, the company’s overall workplace culture rating of 3.9/5 was better than the ASX banking sector average rating of 3.71.

Is lending profitable?

ASX bank shares such as WBC 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 planning to forecast the profits of a bank like WBC or National Australia Bank Ltd (ASX: NAB), knowing how much money the bank lends and what it makes per dollar lent to borrowers is vital. That’s why the NIM is arguably the most vital measure of WBC’s profitability. Across the ASX’s major bank shares, we calculated the average NIM to be 1.92% whereas Westpac Banking Corp bank’s lending margin was 1.9%, 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 Westpac Banking Corp earned 83% of its total income (akin to revenue) just from lending last year.

Why Westpac Banking Corp’s ROE matters

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. Westpac Banking Corp’s ROE in the latest full year stood at 13.1%, meaning for every $100 of shareholder equity in the bank it produced $13.10 in yearly profit. This was forecast the sector average of 11.33%.

Know your downside in bank shares like WBC

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, Westpac Banking Corp had a CET1 ratio of 11.1%. This was less than the sector average.

Westpac Banking Corp dividend valuations are handy (and pretty easy!)

A dividend discount model or DDM is one of the most efficient ways to create a projection of ASX bank shares. To do a DDM we have to arrive at a projection of the bank’s dividends going forward (i.e. the next full-year dividend) and then apply a risk rating. Let’s assume the WBC’s dividend payment goes up 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 WBC shares is $15.13. However, using an ‘adjusted’ or expected dividend payment of $1.25 per share, which is the preferred measure because it uses forecast dividends, the valuation goes to $21.24. The valuation compares to WBC’s current share price of $23.44. 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 projection to $30.35.

What this means is, although the WBC 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 rallying dividends and the positive impact of franking credits. Consider getting our free investment report emailed to you (keep reading).

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