Want to invest ethically for a brighter future?
(but still make lots of money)?

Want to invest ethically for a brighter future? (but still make lots of money)?

 Take Rask’s FREE Ethical Investing course today.

  • Online & 100% free
  • ETFs, shares & Super
Want to invest ethically for a brighter future? 
(but still make lots of money)?

 Take Rask’s FREE online Ethical Investing course.

MQG) shares – are they cheap?

Is it time to buy, hold or sell Macquarie Group Ltd (ASX:MQG) shares?

This is one of the most common questions that our senior investment analysts get asked by Australian investors seeking dividend income. It’s not exclusive to Macquarie Group Ltd, of course.

Commonwealth Bank of Australia (ASX:CBA) and Bendigo and Adelaide Bank Ltd (ASX:BEN) are also very popular stocks on the ASX.

Before I provide you with two valuation models you might use to answer the valuation question yourself, let’s consider why investors like bank shares in the first place.

Alongside the ASX technology and healthcare sectors, bank shares are a favourite for Australian investors. The largest banks, including Commonwealth Bank of Australia and National Australia Bank operate in an ‘oligopoly’. And while large international banks (I’m looking at you, HSBC) have tried to muscle in on our ‘Big Four’, foreign competitors’ success has been very limited.

Tired of the same ol' dividend stocks?

Reversing the PE ratio

Chances are, if you have been actively investing in shares 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 simple 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 simple 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 is overvalued 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.

Using MQG’s share price today, plus the earnings per share data from its 2019 financial year, I calculate the company’s PE ratio to be 16.7x. This compares to the banking sector average of 11x.

Reversing the logic here, we can take the profits per share (EPS) ($6.949) and multiply it by the ‘mean average’ valuation for MQG. This results in a ‘sector-adjusted’ share valuation of $76.98.

Free report: Our expert just named 3 growth stocks for 2020

rask invest stocks to buy now

Wall Street’s oldest valuation model

A dividend discount model or DDM is a more robust way of valuing companies in the banking sector.

DDM valuation models are some of the oldest valuation models used on Wall Street and even here in Australia. A DDM model uses the most recent full year dividends (e.g. from 2019/2020) or forecast dividends for next year and then assumes the dividends remain consistent or grow slightly for the forecast period (e.g. 5 years or forever).

To keep it simple, I’ll assume last year’s annual dividend payments are consistent. Warning: last year’s dividends are not always a good input to a DDM because dividends are not guaranteed since things can change quickly inside a business — and in the stockmarket. So far in 2020, the Big Banks have been cutting or deferring their dividends.

In any case, using my DDM we will assume the dividend payment grows at a consistent rate in perpetuity (i.e. forever), for example, at a yearly rate between 1.5% and 3%.

Next, we have to pick a yearly ‘risk’ rate to discount the dividend payments back into today’s dollars. The higher the ‘risk’ rate, the lower the share price valuation.

I’ve used a blended rate for dividend growth, and I’m using a risk rate between 9% and 14%.

My DDM valuation of MQG shares is $69.38. However, using an ‘adjusted’ dividend payment of $4.00 per share, the valuation drops to $45.49. The valuation compares to Macquarie Group Ltd’s share price of $116.10.

Summary

These two models are just the starting point of the research and valuation process. Banks are very complex companies and if the Global Financial Crisis (GFC) — see Lehman Brothers — taught us anything, it’s that even the ‘best’ banks can go out of business and take shareholders with them!

If I were looking at Macquarie Group Ltd shares and considering an investment, I’d want to know more about the bank’s growth strategy. For exmaple, are they pursuing more lending (i.e. interest income) or more non-interest income (fees from financial advice, investment management, etc.). Then, I’d take a close look at economic indicators such as unemployment, house prices and consumer sentiment. Finally, it’s always important to make an assessment of the management team.

From 200+ ETFs in Australia, our top investment analyst has just identified his #1 ETF for 2021 and beyond.

Low fees? Check.

Long-term growth potential? Check.

Regular cash returns? Check!

This ETF makes investing in ETFs "Super-Easy".

Simply click here or enter your email address below to access the full ETF report, ticker code, and step-by-step investment guide. Our expert's #1 ETF report is completely free.

No gimmicks, no payment, no credit card info. Just enter your email address below and we'll send you the report right away.

From 200+ ETFs in Australia, our top investment analyst has just identified his #1 ETF for 2021 and beyond.

Low fees? Check.

Long-term growth potential? Check.

Regular cash returns? Check!

This ETF makes investing in ETFs "Super-Easy".

Simply click here to access the full ETF report, ticker code, and step-by-step investment guide. Our expert's #1 ETF report is completely free.

No gimmicks, no payment, no credit card info. Just click the link below and enter your email address. We'll send you the report right away.

CLICK HERE TO GET THE REPORT

Unsubscribe anytime. Read our TermsFinancial Services GuidePrivacy Policy. We’ll never sell your email address. Our company is Australian owned.

Information warning: The information on this website is published by The Rask Group Pty Ltd (ABN: 36 622 810 995) is limited to factual information or (at most) general financial advice only. That means, the information and advice does not take into account your objectives, financial situation or needs. It is not specific to you, your needs, goals or objectives. Because of that, you should consider if the advice is appropriate to you and your needs, before acting on the information. If you don’t know what your needs are, you should consult a trusted and licensed financial adviser who can provide you with personal financial product advice. In addition, you should obtain and read the product disclosure statement (PDS) before making a decision to acquire a financial product. Please read our Terms and Conditions and Financial Services Guide before using this website. The Rask Group Pty Ltd is a Corporate Authorised Representative (#1280930) of AFSL #383169.

Keep reading:

General Financial Advice warning
The information on this website is general financial advice only. That means, the advice does not take into account your objectives, financial situation or needs. Because of that, you should consider if the advice is appropriate to you and your needs, before acting on the information. In addition, you should obtain and read the product disclosure statement (PDS) before making a decision to acquire a financial product. If you don’t know what your needs are, you should consult a trusted and licensed financial adviser who can provide you with personal financial product advice. Please read our Terms & Conditions and Financial Services Guide before using this website.

© Rask Australia 2020

Join 20,000+ smart investors

Join the Rask Australia mailing and we’ll send you free investment reports, podcasts, expert insights, investing courses, ASX news and lots, lots more. All free. 

Unsubscribe anytime. Read our TermsFinancial Services GuidePrivacy Policy. We’ll never sell your email address. Our company is Australian-owned.

feedback-icon

What can we do better? Please give us us some feedback :)

We care about your experience, please let us know if you have any suggestions to improve our site.