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The WBC share price might look cheap, but here are easy ways to study it

Trying to determine a reliable valuation of Westpac Banking Corp (ASX: WBC) shares is just as much art as science. However, the research and valuation process is arguably the most essential part of successful investing and should not be neglected.

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.

The WBC share price might look cheap, but here are easy ways to study it

Step 1. Assessing culture

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.

Step 2. Lending

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 essential 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.

Step 3. WBC return on equity

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%.

Step 4. Westpac Banking Corp’s CET1 ratio

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.

Step 5. Valuations using dividend payments

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 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 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 $19.74. 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 $30.35.

While WBC shares might appear decent value right now based on this statistical method, please don’t make a decision to buy or sell WBC shares based on this article. Consider reading at least two or three years’ worth of Westpac Banking Corpannual reports and then seek out good investors and analysis which disagrees with your perspective — that’s an informed way to figure out if you’re making a good decision based on rigorous analysis and countering opinion. Finally, before going any further with WBC or BOQ shares, I suggest getting a copy of our free investment report.

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