CM – A simple guide to evaluating the ANZ share price

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In this article we explain how easy it can be to create a valuation of an ASX bank stock like ANZ Banking Group (ASX: ANZ). While it may seem « easy » to build a valuation model for a company, no stock valuation or forecast is guaranteed. If value investing were as easy as what we’re about to show you, everyone would be millionaires!

Our largest bank stocks account for more than a third of the local stock market, as measured by the market capitalization of the 200 largest companies in S&P / ASX 200 index.

If you really want to understand how a dividend stock like a bank or a REIT is valued, watch the tutorial video from the Rask Australia analyst team.

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If you’ve invested in individual stocks or companies for more than a few years, you’ve heard of P / E ratios. The price / earnings ratio, or “PER,” compares a company’s share price (P) to its most recent annual earnings per share (E). If you bought a coffee shop for $ 100,000 and it made $ 10,000 in profit last year, that’s a price-to-earnings ratio of 10x ($ 100,000 / $ 10,000). “Profit” is just another word for profit. So the P / E ratio basically says « Price-to-Year Earnings 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) used to support it. However, one of the basic ratio strategies even professional analysts use to value a stock is to compare the company’s P / E to that of its competitors to determine whether the stock is over the top or cheap. It’s like saying, « If all other stocks in the banking sector are valued at a P / E of X, it should be ». We go one step further in this article. We apply the principle of mean reversion and multiply earnings per share (E) by the average P / E ratio of the sector (E x sector PE) to calculate the value of an average company.

If we take today’s ANZ – Taking the share price ($ 28.4) along with the 2020 fiscal year earnings (aka earnings) per share data ($ 1.21), we can calculate the company’s P / E to 23.5x. That compares to the banking sector’s average P / E of 24x.

Next, take earnings per share (EPS) ($ 1.21) and multiply it by the average P / E for the ANZ sector (banks). This results in a « sector-adjusted » PE valuation of $ 28.97.

A DDM or dividend discounting model is very different from ratio valuations like P / E in that you can forecast future cash flows (dividends are called  » Cashflow « is used). Since the banking sector has proven to be relatively stable in terms of stock dividends, the DDM approach can be used. However, we wouldn’t use this model for technology stocks, for example.

Basically, we only need one input into a DDM model: dividends per share. Then we make some assumptions about the annual growth of the dividend (e.g. 2%) and the risk level of the dividend payment (e.g. 7%). We used the most recent dividends of the entire year (e.g. the last 12 months or LTM) and then assumed that the dividends would remain constant but increase slightly.

To make this DDM easy to understand, let’s assume it assumes that last year’s dividend payment ($ 0.60) will increase at a constant rate into the future at a fixed annual rate.

Next we choose the « risk » rate or the expected return. This is the rate we use to discount future dividend payments to today’s dollar. The higher the « risk » rate, the lower the stock price rating.

We used an average dividend growth rate and a risk rate between 6% and 11%.

This simple DDM rating of ANZ stocks is $ 11.44. However, with an « adjusted » dividend payment of $ 1.40 per share, the valuation is $ 25.10. The expected dividend valuation compares to the ANZ Banking Group’s share price of $ 28.40. Since the company’s dividends are fully prepaid, you can make another adjustment and base the valuation on a “gross” dividend payment. That means the cash dividends plus the franking credits (available for eligible shareholders). Using the forecast gross dividend payment ($ 2.00), we estimate the forecast price of ANZ stock to be $ 35.85.

Both of our models could be used as an introductory guide to how the valuation process works. Analyzing a bank stock like ANZ Banking Group is a complicated task. When we look at the stock and consider an investment, the first thing we want to do is learn more about the bank’s growth strategy. For example, track more lending (i.e. interest income) or more non-interest income (financial advisory fees, investment management fees, etc.).

Next, take a close look at economic indicators like unemployment, house prices and consumer sentiment. Where are you heading? Finally, we think it is important to make an assessment of the management team. For example, when we took data on ANZ’s culture, we found it wasn’t a perfect 5/5. Culture is one thing to think about carefully.

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Are you wondering where to invest right now? Do you have cash that is “sitting on the sidelines”? Are you looking for dividend income AND growth but not sure where to start? Rask’s seasoned ASX analyst team just released a full report detailing where we would be investing $ 10,000 right now. Not only do we offer these 11 investment ideas completely FREE, we have also published a detailed podcast on the report!
Whether you have $ 2,000 or $ 50,000, our brand new Analyst Report could help transform your watchlist. Now you can have the full analyst report emailed to you for FREE by CLICKING HERE NOW.

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The information on this website is for general financial advice only. This means that the advice does not take into account your goals, financial situation or needs. For this reason, you should check that the advice is suitable for you and your needs before reacting to the information. In addition, you should obtain and read the Product Disclosure Statement (PDS) before making a decision to purchase a financial product. If you do not know your needs, you should turn to a trusted and licensed financial advisor who can advise you personally on financial products. Please read our & Terms and Conditions and Financial Services Guide prior to using this website.

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A simple guide to evaluating the ANZ share price

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