Our largest bank holdings account for more than a third of the local share market, measured by the market capitalization of the largest 200 companies in the S&P/ASX 200 index.
If you Really To understand how to value a dividend stock, such as a bank or REIT, you should consider watching a tutorial video from the analyst team at Rask Australia, or signing up for one of our free online investment courses.
You can subscribe to the Rask Australia YouTube channel and get the latest (and free) value investing videos by clicking here.
Using the PE ratio for valuation
The PE ratio compares a company’s share price (P) to its annual earnings per share (E) (note: ‘earnings’ is another word for profitability).
There are three simple ways to use the PE ratio quickly. First, you can use ‘intuition’ and say ‘if it’s lower I’ll buy shares’ or ‘if it’s more than 40x I’ll sell shares’ (whatever works for you).
Secondly, you can compare the PE ratio of a stock like BOQ with the WBC or sector average. Is it more or less? Does it deserve to be more expensive or cheaper? Third, you can take the earnings/profit per share of the company you are valuing and multiply that number by a PE multiple that you think is appropriate. For example, if a company’s earnings per share (E) were $5 and you believed the stock was ‘worth at least 10x its earnings’, it would be worth, according to you, $5 x 10 = $50 per share.
If we take today’s BOQ share price ($6.36), along with its FY24 earnings per share (i.e. profit) of ($0.41), we can calculate the company’s PE ratio at 15.5x. This compares to the banking sector average PE of 19x.
Next, take the earnings per share (EPS) ($0.41) and multiply it by BOQ’s sector (banking) average PE ratio. This results in a ‘sector adjusted’ PE valuation of $7.71.
BOQ Share Price: Dividend Valuation
The Dividend Discount Model or ‘DDM’ is a more robust method of valuing companies in the banking sector.
DDM valuation models are the oldest proper valuation models used by professional analysts or brokers on Wall Street (note: just because they’re old doesn’t make them ‘good’). A DDM model takes the most recent full year of dividends (eg from the last 12 months or LTM), or forecasts dividends for the next year, and then Assumes that profits remain constant or increase for the forecast period.. The only other number you need is the ‘hazard’ rate (eg 7%) which is further explained below.
To evaluate, use this formula: Share price = Full year dividend / (Rate of risk – Rate of return). It’s a good idea to do calculations with a few different growth and risk assumptions, then take an average valuation. This helps remove some of the uncertainty.
To simplify this DDM, we will assume that last year’s dividend payment ($0.34) grows at a constant rate each year.
Next, we determine the ‘risk’ rate or expected rate of return. This is the rate at which we discount future dividend payments in today’s dollars. A higher ‘risk’ rate results in an undervaluation of the share price.
We’ve used a blended rate of return and a risk rate between 6% and 11%, then averaged the results.
This approach yields a BOQ share price of $7.19. However, using an ‘adjusted’ dividend payout of $0.35 per share, the valuation jumps to $7.40. The expected earnings estimate compares to Bank of Queensland Ltd’s share price of $6.36.
Since the company’s dividend is fully transparent, you can make another adjustment and make a valuation based on the ‘gross’ dividend payout. ie cash dividends plus franking credits (available to eligible shareholders). Using the forecast gross dividend payout of ($0.50), our BOQ share price comes out to $10.57.
| Growth rate | ||||
| 2.00% | 3.00% | 4.00% | ||
|
Hazard ratio |
6.00% | $8.75 | $11.67 | $17.50 |
| 7.00% | $7.00 | $8.75 | $11.67 | |
| 8.00% | $5.83 | $7.00 | $8.75 | |
| 9.00% | $5.00 | $5.83 | $7.00 | |
| 10.00% | $4.38 | $5.00 | $5.83 | |
| 11.00% | $3.89 | $4.38 | $5.00 | |
Key Summary
Our two models can be used as an introductory guide to how the assessment process works. Analyzing a bank share like Bank of Queensland Limited is a complex task. If we were looking at shares and considering an investment, we would first want to know more about the bank’s growth strategy. For example, are they getting more lending (ie interest income) or more non-interest income (fees from financial advice, investment management etc.).
Next, take a closer look at economic indicators such as unemployment, housing prices and consumer sentiment. Where are they going? Finally, we believe it is important to assess the management team. For example, when we pulled data on BOQ’s culture, we found that it’s not a perfect 5/5. Culture is something to think about carefully.
