Note: This is part 1 of a 2-part series on trading and valuing the big four Australian banks. Part 2 shall be forthcoming soon.
Fellow equities blogger Sell on News completed an excellent thematic post on the bubble like growth of the finance industry recently. In the face of a likely change in how capital is costed, he rightly suggests:
So what does this mean for investment? A probable long term portfolio shift from finance stocks to what will be increasingly scarce resources (even water) food and energy. Manufacturing has been globalised, which has destroyed margins. And the era of debt driven speculation is not looking good, so the financial sector may find their conventional forms of theft a little more challenging.
Back in May 2010, my business partner (Q Continuum) and I re-evaluated our position on the banking industry.
Now, we are not economists and do not use top-down macro-economic analysis to quantitatively value a company. However we do lean heavily on the first class analysis provided at MacroBusiness to give us a qualitative macro perspective.
We are first and foremost business analysts, then behavioural analysts i.e first, what is the value then what is the price people are prepared to pay?
So our questions back then were:
Are these businesses sustainable?
Do they have any pricing power?
What are the inherent risks of owning a bank stock?
Will the market re-value banks in light of this?
Good, but only just Up to May last year, we had all four major banks listed and categorised as “Good, No Competitive Advantage”. A little explanation of our “Quality Ladder” – or how we categorise a company – is in order here before moving on.
A+, High Achievement, Competent and Poor We contend that there are four “grades” of businesses, based on quality and then quantitative metrics. We use a Quality Ladder to filter out the diamonds from the crud, as shown below:
Although none of the banks have dropped to our new valuation range (which for comparison are in the same price range after the rebound rally in April to June 2009), they have not appreciated as some have expected.
As a result, we still consider them considerably overvalued, which leads one to question – even after the large correction in world markets this week – is there any further downside to the banks, and how can an investor/trader profit in the short and long term?
In Part 2 of this series, I will explore some techniques for trading the Big 4 banks.
Please note that Empire Investing may have or is considering future positions in any or all the companies mentioned above. This post is general information only and not a recommendation.