Australia’s big banks make up around 30% of the share market, measured by market capitalisation (total company size).
It’s easy to see why ASX bank shares have been so popular since the early 1990s, when Australia experienced a recession and mortgage interest rates were over 15%!
One great thing about banks is that, for the most part, they are ‘implicitly’ protected from complete financial collapse or bankruptcy because a bank going out of business would be a political nightmare. In saying that, as we’ve seen recently, shareholder returns are never guaranteed.
BEN share price: valuation in action
If you have been investing in individual stocks or companies for more than a few years you will have heard about the PE ratio. The price-earnings ratio or ‘PER’ compares a company’s share price (P) to its most recent full-year earnings per share (E). If you bought a coffee shop for $100,000 and it made $10,000 of profit last year, that’s a price-earnings ratio of 10x ($100,000 / $10,000). ‘Earnings’ is just another word for profit. So, the PE ratio is basically saying ‘price-to-yearly-profit multiple’.
The PE ratio is a very basic tool but it’s 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 even professional analysts will use to value a share is to compare the company’s PE ratio with its competitors to try to determine if the share price is too high, or undervalued. It’s akin to saying: ‘if all of the other banking sector stocks are priced at a PE of X, this one should be too’. We’ll go one step further than that in this article. We’ll apply the principle of mean reversion and multiply the profits per share (E) by the sector average PE ratio (E x sector PE) to calculate what an average company would be worth.
If we take the BEN share price today ($11.08), together with the earnings (aka profits) per share data from its FY24 financial year ($0.87), we can calculate the company’s PE ratio to be 12.7x. That compares to the banking sector average PE of 20x.
Next, take the profits per share (EPS) ($0.87) and multiply it by the average PE ratio for BEN’s sector (Banking). This results in a ‘sector-adjusted’ PE valuation of $17.28.
What are BEN’s dividends worth to an investor?
A DDM or dividend discount model differs quite significantly from ratio valuations like PER because it requires forecasting cash flows – using dividends as a proxy for cash flow – into the future. The DDM approach works well for the banking sector, which has a history of relatively stable dividend payments. However, it’s less suitable for industries like technology, where companies are more focused on growth than paying consistent dividends.
The key input for a DDM is the dividend per share. From there, we make assumptions about the annual growth rate of the dividend (e.g. 2%) and the associated risk level, or required return (e.g. 7%). For this analysis, we’ve used the most recent full-year dividends (e.g. from last 12 months or LTM) and assumed the dividends remain stable but grow modestly over time.
The valuation formula is straight forward: Share price = full-year dividend / (risk rate – dividend growth rate). It’s advisable to do the calculation with a range of growth and risk rate assumptions, then average the results. This way you can account for more of the uncertainty and arrive at a more balanced valuation estimate.
To simplify this DDM, we will assume last year’s dividend payment ($0.63) expands at a consistent rate each year.
Next, we determine the ‘risk’ rate or expected return rate. This is the rate at which we discount the future dividend payments back to today’s dollars. A higher ‘risk’ rate results in a lower share price valuation.
We’ve used a blended rate for dividend growth and a risk rate between 6% and 11%, then averaged the results.
This approach yields a valuation of BEN shares of $13.32. However, using an ‘adjusted’ dividend payment of $0.65 per share, the valuation goes to $13.75. The expected dividend valuation compares to Bendigo & Adelaide Bank Ltd’s share price of $11.08.
Since the company’s dividends are fully franked, you could make one further adjustment and do the valuation based on a ‘gross’ dividend payment. That is, the cash dividends plus the franking credits (available to eligible shareholders). Using the forecast gross dividend payment ($0.93), our valuation of the BEN share price comes out at $19.64.
| Growth rate | ||||
| 2.00% | 3.00% | 4.00% | ||
|
Risk rate
|
6.00% | $16.25 | $21.67 | $32.50 |
| 7.00% | $13.00 | $16.25 | $21.67 | |
| 8.00% | $10.83 | $13.00 | $16.25 | |
| 9.00% | $9.29 | $10.83 | $13.00 | |
| 10.00% | $8.13 | $9.29 | $10.83 | |
| 11.00% | $7.22 | $8.13 | $9.29 | |
BEN share price summary
It goes without saying that these two valuation strategies are only the starting point of the process for analysing and valuing a bank share like BEN. And if we were looking at bank shares like Bendigo & Adelaide Bank Ltd, we would definitely want to know whether or not it made more sense to just invest in a low-cost, dividend-paying ETF like the Vanguard Australian Shares Index ETF (ASX: VAS).
Other questions to ask might be: Are the net interest margins holding up if they are pursuing more lending (i.e. interest income)? How are they dealing with regulation if they seek more non-interest income (fees from financial advice, investment management, etc.)?
Finally, it’s always important to make an assessment of the management team. For example, when we pulled data on Bendigo & Adelaide Bank Ltd’s culture we found that it wasn’t a perfect 5/5. No company has a perfect culture, of course. However, culture is one thing we think about a lot when analysing companies to buy and hold over the very long term (10+ years).
