How to achieve a price target is one of the most popular questions asked by our senior investment analysts by Australian investors, particularly those seeking dividend income. Of course this is not exclusive to National Australia Bank Limited.
Westpac Banking Corporation (ASX: WBC) and ANZ Banking Group (ASX: ANZ) is also a very popular bank share on the ASX.
Before we get into the two valuation models you can use to answer this question yourself, let’s consider why investors hold bank shares in the first place.
Along with the tech and industrial sectors, the financial/banking industry is a favorite for Australian investors. Major banks, incl Commonwealth Bank of Australia And National Australia Bank Work in an ‘oligopoly’.
And while major international banks, such as HSBC, have tried to encroach on our ‘Big Four’, foreign competitors have had very limited success. In Australia, ASX bank shares are particularly favored by profit investors looking for clear credit.
Putting a price on NAB’s earnings
Chances are you have heard of PE ratio if you have been actively investing in stocks for a few years. The price-to-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 ,000 100,000 and it made a profit of $10,000 last year, it is worth a ratio of 10x (,000 100,000 / $10,000). ‘Revenue’ is just another word for profit. So, PE ratio is basically saying ‘Price to Annual Profit multiple’.
The PE ratio is a very common tool but it’s not perfect so it’s important to use it with other techniques (see below) to back it up. That said, one of the common ratio strategies that even professional analysts will use to value a stock is to compare the company’s PE ratio with that of its competitors to try to determine whether the share price is overpriced or underpriced. This is equivalent to saying: ‘If all stocks in the other banking sector are priced at a PE of X, so should these’. We will go a step further than this article. We will apply the principle of multiplying the earnings per share (E) by the sector average PE ratio (ex sector PE) by the average company value and multiplying the earnings.
If we take NAB’s share price today (.3 42.35), along with its FY24 earnings (aka profit) per share figure (2.26), we can calculate the company’s PE ratio at 18.7x. This compares with the banking sector average PE of 19x.
Next, take the earnings per share (EPS) ($2.26) and multiply it by the average PE ratio of NAB’s sector (Banking). This results in a ‘sector adjusted’ PE valuation of .042.03.
DDM Valuation of NAB Share Price
When done carefully and thoughtfully, a dividend discount model, or DDM, is a more efficient way to value companies in the banking sector.
DDM valuation models are among the oldest valuation techniques used on Wall Street and even in Australia. A DDM model relies on the most recent full-year profits (such as from the last 12 months or LTM) or forecasted profits for the coming year. After that Assumes that profits remain constant or grow at a nominal rate for a forecast period (such as 5 years or indefinitely).. The only additional input required is the ‘Risk’ rate (eg 7%) which is explained below.
To work out the valuation, use this formula: Share Price = Full Year Profit / (Risk Rate – Profit Growth Rate). It is good practice to run the model with a few different growth and risk assumptions, then average the valuation. This approach helps to account for uncertainty and improves the reliability of the assessment.
To simplify this DDM, we will assume that last year’s dividend payment (69 1.69) 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 return future dividend payments in today’s dollars. A higher ‘risk’ rate results in a lower share price value.
We have used compounding rates for profit growth and risk rates between 6% and 11%, then averaged the results.
From this perspective, NAB’s share price is $35.74. However, using an ‘adjusted’ dividend payout of 71 1.71 per share, the price goes to .1 36.16. The expected dividend compares to National Australia Bank Limited’s share price of .3 42.35.
Since the company’s profits have been fully accounted for, you can make another adjustment and assess based on the ‘gross’ profit paid. ie cash dividends plus franking credit (available to eligible shareholders). Using the forecast gross dividend payout (44 2.44), our estimate of NAB share price comes to .6 51.66.
| Growth rate | ||||
| 2.00% | 3.00% | 4.00% | ||
|
Hazard ratio |
6.00% | . 42.75 | .00 57.00 | . 85.50 |
| 7.00% | . 34.20 | . 42.75 | .00 57.00 | |
| 8.00% | . 28.50 | . 34.20 | . 42.75 | |
| 9.00% | .4 24.43 | . 28.50 | . 34.20 | |
| 10.00% | .3 21.38 | .4 24.43 | . 28.50 | |
| 11.00% | .00 19.00 | .3 21.38 | .4 24.43 | |
Time for more research
Please keep in mind that these are evaluation methods Just the starting point Research and evaluation process. Please remember that. Banks are very complex companies and if the GFC of 2008/2009 taught investors anything, it is that even the ‘best’ banks can go out of business and take shareholders with them.
If you are looking at shares of National Australia Bank Limited and considering an investment, take your time to learn more about the bank’s growth strategy. For example, is it generating 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. Finally, it is always important to evaluate the management team.
