National Australia Bank Ltd (ASX:NAB) shares – research steps to take before diving in head first

Here are five things to look at if you are researching National Australia Bank Ltd (ASX:NAB) shares, or a competitor like Westpac Banking Corp (ASX:WBC).

NAB is one of Australia’s four largest banks in terms of market capitalisation, profits and customers. As of 2020, NAB was also one of Australia’s largest lenders to businesses, but it also has operations in residential lending. NAB operates the online-only Ubank. 

National Australia Bank Ltd (ASX:NAB) shares – research steps to take before diving in head first

1. Assess management & the workplace

It’s fair to say, we think, that a good workplace and culture amongst staff can lead to improved retention of high-quality personnel and, in turn, that determines the long-term success of a company.

One way Aussie investors can take a ‘look inside’ a company like National Australia Bank Ltd is to use a HR/jobs website like Seek. Seek’s website includes data on companies, including employee reviews. According to the most recent data we pulled on NAB, the company’s overall workplace culture rating of 3.2/5 was below the sector average of 3.23.

2. Look at the banking margins

Banks such as NAB need debt and good profit margins to make their business profitable. In basic terms, a bank gets money from term deposit holders and wholesale debt investors and lends that money to homeowners, businesses and investors. The difference between what a bank pays to savers and what it makes from mortgage holders (for example) is the net interest margin or NIM. Rememeber: when it comes to NIMs, the wider the margin the better.

If you are forecasting the profits of a bank like NAB or ANZ Banking Group (ASX:ANZ), knowing how much money the bank lends and what it makes per dollar lent to borrowers is essential. That’s why the NIM is arguably the most important measure of a bank’s profitability. Across the ASX’s major banks, we calculated the average NIM to be 1.93% whereas the bank’s lending margin was 1.77%, highlighting it delivered a lower-than-average return from lending compared to its peer group. This may happen many reasons, which are worth investigating.

The reason analysts study the NIM so closely is because National Australia Bank Ltd earned 80% of its total income (akin to revenue) just from lending last year.

3. What’s the ROE?

Return on shareholder equity or just ‘ROE’ helps you compare the profit of a bank against its total shareholder equity, as shown on its balance sheet. The higher the ROE the better. National Australia Bank Ltd’s ROE in the latest full year stood at 6.%, meaning for every $100 of shareholder equity in the bank it produced $6.00 in yearly profit. This was below the sector average of 6.99%.

4. The buffer against losses

For Australia’s banks the CET1 ratio (aka ‘common equity tier one’) is paramount. CET1 represents the bank’s capital buffer which can go towards protecting it against financial collapse. According to our numbers, National Australia Bank Ltd had a CET1 ratio of 11.4%. This was below the sector average.

5. What are shares actually worth?

A dividend discount model or DDM is one of the easier and more efficient ways to value bank shares. To do a DDM we have to estimate the bank’s dividends going forward (i.e. the next full-year dividend) and then apply a risk rating. Using a simple DDM, let’s assume the bank’s dividend payment grows at a consistent yearly rate into the future somewhere between 2% and 3%. For the risk rating, we will use multiple risk rates between 6% and 11% and then average the valuations.

So what’s the result? Our simple DDM valuation of NAB shares is $9.46. However, using an ‘adjusted’ dividend payment of $1.12 per share, the valuation goes to $17.65. The valuation compares to NAB’s current share price of $26.10.

What this means is, although the shares might seem expensive using our simple DDM model, don’t make a decision based on this article. Please go away now and consider all of the risks and ideas we presented here. While you’re at it, you might also consider a diversified shares ETF, dividend fund or at least grab a copy of our free ETF investment report below.

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