The Big 4 Aussie Bank Stocks (ANZ, CBA, Westpac & NAB) are the bluest of blue-chip. They’re the type of companies that your parents or grandparents would tell you to invest in because they’re ‘safe and steady’. But I’m not so sure that’s necessarily relevant to investors in the early phases of their investing journeys. Here’s why.
The first issue I have with the Big 4 is that they’re bloody expensive.
The big banks are trading at quite high price to earnings ratios compared to their historical averages after rallying strongly off their March 2020 lows. In most cases, a higher P/E multiple implies that the market is pricing in earnings growth into a company’s share price. But in the case of the Big 4, I’m skeptical as to whether the market’s expectations for growth are justified.
All this means that they’re quite expensive, especially when you consider their upside for earnings growth is limited over the next 5 years. Here’s a table of where their P/E’s sit now in comparison to their 5 year averages. to show you what I mean.
|Bank||5 Yr Average P/E (2014-2019)||Curret P/E*|
*As of the 30th of November 2020.
The Big 4 are facing earnings headwinds
The main limiting growth factor for the big banks is the low-interest rate environment we’re in. The Reserve Bank of Australia has indicated that interest rates will stay relatively unchanged for the next three years after dropping the cash rate to an all-time low of 0.10%, which puts pressure on profit margins for the banks.
The thing with the big banks is that they operate on a margin. So, if they’re lending money out at 2%, that’s a 2% margin that the banks have to work with to draw profits. While this may seem great for consumers, it’s terrible for the bank’s bottom lines.
Most of the time, you’ll find that a company’s earnings are closely correlated with its stock price. If earnings rise, so does the stock price. If earnings fall, well, I’m sure you can figure out what happens next!
In the case of the Big 4, earnings growth seems to be constrained by the stranglehold of low-interest rates, translating to the limited upside for share price growth.
Alphabet, the parent company of Google (NASDAQ:GOOGL) is a great example of the symbiotic relationship between earnings growth and share price growth. The tech giant has grown its EPS at a healthy rate of roughly 15% per year over the past 10 years (2009-2019). In the corresponding period, Alphabet’s stock price has risen by roughly 15% per year. Coincidence? I think not.
Their earnings history doesn’t paint a bright picture either
While the Big 4 Bank’s earnings prospects don’t look too great, their earnings history is much the same.
The table below shows what an investment of $10,000 in each Big 4 would have produced in capital gains over the past 10 years (2010-2020) compared to an identical investment in the S&P 500 index, and Alphabet (Google).
|CAGR (Compounded Annual Growth Rate) 10Y*||Growth Of $10,000.00*|
The Big 4 are being disrupted by nimble neo-banks
Neobanks (a type of direct bank that operates exclusively online) like 86 400, Xinja, Volt & Douughh to name a few are attempting to do to the Big 4 what AirBnb did to Hotels, or what Amazon did to the bricks and mortar book store.
The recent rise in Neobanks is thanks to a new set of rules the Australian Prudential Regulation Authority (APRA) created in 2018. The new rules essentially simplified the process of getting your banking license, making it easier for Start-Up Neobanks to enter the banking market dominated by the Big 4.
The fact that Neobanks operate entirely online and don’t have physical presence (branches), and operate with fewer staff means they can operate at a much lower cost base in comparison to the Big 4.
Neobanks are also blessed with the benefit of starting from a blank sheet of paper, which means they’re not carrying any legacy systems and infrastructure.
They’re also very user friendly and customer-focused. Most of them come with sleek, easy to use platforms offering budgeting tools and other nuances you don’t get with the Big 4.
So, what does this mean?
Neobanks can pass on their cost savings in the form of attractive interest rates on savings accounts for their customers while providing them with a user-friendly experience. And most importantly, place market share pressure on the Big 4.
To give you an idea of how far Neobanks have come, this year the ASX welcomed its first-ever Neobank following the listing of Douugh (ASX:DOU). Incredibly, they managed to raise $6 million in equity from an over-subscribed pre-IPO. For the record, Volt is also looking to float their shares sometime in 2021.
Final thoughts on the Big 4
A good old-fashioned Big Bank might be just right for your portfolio or it might not. Above all, it’s important is that you assess where you are in your investing journey and how well The Big 4 aligns with your investing goals.
All of the Big 4 boast dividend yields north of 2.8%, which is attractive if you’re after a steady stream of income. Unfortunately, that healthy dividend yield is likely to continue to come at the expense of capital growth given the Big 4 are under significant earnings pressure.
For someone early in their investing journey like me, I’d much rather invest for capital growth while generating income from other sources like my job or a side hustle. Those juicy dividends payments can wait for when I’m ready to rely on them for income later on in life.
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Disclaimer: This website (the “The Money Pal”) is published and provided for informational and entertainment purposes only. The information in the Blog constitutes the Content Creator’s own opinions and it should not be regarded as financial advice.