Is the party over for banks?
Broker reports editor |
15 November 2013
A report by Deutsche Bank is suggesting that it may be time for investors to switch out of banks stocks, or at least look for other options. Banks have been especially popular with SMSF investors because of the high dividend yields and relatively low risk. But that has mean that bank stocks have had a run up in price.
In 2009, the value of bank shares (market capitalisation) was about 12% of GDP. It is now 27% of GDP. In 2009 bank shares were 18% of the share market, now they have soared to 32%. Investing in banks has become an obssession with Australian investors, many of them SMSFs. It has a logic to it. Why leave money in bank term deposits getting a low interest rate when you can buy shares in the same bank and get twice the yield on an after tax basis )after franking)? The risk of failure is about the same, negligible, so the only real exposure is to changes in the share price. If it goes against you, you do not sell the shares, y9uo just hang on for yield.
But all good things can change. Deutsche points out that banks look expensive, on a range of metrics The 12m forward earnings multiple (PE ratio) is 14.1 times, 30% above the 25yr avg of 10.8 times. Banks are at a 9% PE discount to the rest of the market, compared to the average discount of 16%. - The banks PE is higher than the historical average despite medium-term growth prospects stepping down. This has not happened in the rest of the market.
Australian banks are at a 85% price-to-book premium to global banks, vs 35% normally. The PE premium is 30%, vs 10% normally. Banks still offer a superior dividend yield, but the gap has shrunk from 1.5%pts to under 1%pt.
Deutsche points out that cCedit growth should improve, helping bank earnings, but that seems already priced i:
"Firming housing activity should soon boost housing credit, but that seems largely factored into earnings forecasts already. On earnings generally, it’s true that bank earnings forecasts have proved more realistic over time, but it looks as if cyclical earnings are firming at the moment."
So where should investors look? Deutsche comments that resources look cheap, and the global cycle looks to be turning up. The resources earnings multiple (PE) is 13.8 times, which is below the long-run average and low vs the market. Share prices have heavily lagged commodity price moves. The broker notes that The improvement in US/EU purchasing manufacturing indexes (an indicator of economic strength) suggests considerable scope for Chinese exports to rise further, adding to growth. The key areas of Chinese industrial production (cement, steel, electricity) are around 2-year highs. Asian IP growth is now at rates consistent with firming commodity prices.
Deutsche goes on:
"Banks have enjoyed a strong run, outperforming the market over the past two years. This has taken valuations to expensive levels across a broad range of metrics. Starting with 12m forward PE ratios, banks are currently at 14x, compared to the 25-year average of ~11x.
"A smaller PE discount for banks might be appropriate if banks’ medium term growth prospects had improved compared to the rest of the market. But the opposite seems to be the case. Analysts had been projecting medium-term EPS growth for banks of ~9% through much of the past decade, but this has shrunk to 5% currently, given the downshift in credit growth. For the market as a whole, little has changed on either the PE or medium-term growth front. Thus, on a PE-Growth basis, banks look very expensive."
The graph beliow shows the premium for investing in financials, not taking into account franking and accounting for the yield on a 10 year government bond. As is clear, the financial advantage of buying bank shares over a term deposit is steadily declining, although this does not include the effect of the tax benefit from franking (dividend imputation), which does contribute to the attraction: