The group is asked to compare and contrast the financial performance of both ANZ and NAB banks and to come up with a consolidated view of which bank is better from a investor point of view. Price-to-Earnings ratios (P/E), Return on Equity (ROE), Capital Adequacy Ratio, Dividend Yield ratio and Weighted Average Cost of Capital (WACC) were calculated in this report as indicators as they are deemed as the most relevant ratios in this context. The P/E ratio gives an indication of the number of years it will take for net profit to “cover” the price paid for the share assuming no further shares are issued and same net profit is earned (Phan, 2011). ROE is a crucial ratio that allows one to inspect earnings performance of companies (Pysh, 2012).
Capital adequacy ratios are measures of the amount of a bank’s capital expressed as a percentage of its risk-weighted assets (on and off balance sheet) and are significant indicators to measure the quality of its assets, stability, market risk, credit risk concentration, and adequacy of provisioning and the effectiveness of the bank’s management systems for monitoring and controlling risks (APRA, 1999). Dividend yield ratio shows how much earnings of the company are being distributed in dividend versus reinvestment (Marshall, 2010). ROA gives investors a gauge of how effectively the company is converting the money it has to invest into net income.
In fact, a higher ROA is better as this means the company is earning more money on less investment (Investopedia). WACC calculates a firm’s cost of capital where all capital sources like common stock, preferred stock, bonds and any other long-term debt are all proportionately weighted. With all factors being equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk (Investopedia). After analysing the trend of these ratios individually and as a whole, ANZ is concluded to be a better performer for this period. Table of Contents Executive Summaryi
Table of Contentsii Part A Discussion1 1) Price-to-Earnings Ratio (P/E)1 2) Return on Equity (ROE)1 3) Capital Adequacy Ratio (CAR)2 4) Dividend Yield Ratio3 5) Weighted Average Cost of Capital (WACC)3 Part B Discussion5 References6 Appendices7 Part A Discussion 1) Price-to-Earnings Ratio (P/E) A P/E ratio between 10 and 15 times is the general gauge for stocks in the banking sectors (ASR). Generally, the lower the P/E ratio, the better value a stock is and the company is expected to take less time to generate earnings equivalent to the current share price (ASR). However, a lower P/E ratio can also be generated with one-off abnormal earnings (Phan, 2011).
In 2008, share prices dropped mainly due to the US sub-prime crisis, which started in 2007 (Lixi, 2008). This had a huge impact on the P/E ratio for 2008, which is slightly below the threshold of 10 times. The P/E ratio for ANZ was higher than NAB in 2009 and there was lesser fluctuation in ratio. Share prices tend to rise with improved economic conditions, and with stimulus packages being distributed all over the world, there was uplift in the global economy, hence driving share prices (Larsen, 2012). However, falling earnings over 2009 caused both P/E ratios to rise. NAB’s P/E ratio increased a significant amount and overtook ANZ’s. Over the 5 years, NAB’s P/E ratio fluctuation is observed to be consistently higher than ANZ’s.
Moreover, NAB’s higher P/E ratio might be due to investors’ high expectations, which were not supported by earnings. The P/E ratios returned to a more normal course in 2010 due to improved earnings (See Appendices 1). In 2011, earnings were higher than in 2010 but the drop in market share price caused P/E ratio to decrease again. This drop might be linked to concerns over the uncertainties around sovereign debt in Europe. 2) Return on Equity (ROE) According to Forbes, ROE is a time-honoured metric designed to measure companies’ capacity to convert assets into profit (Forbes, 2012). A company with higher ROE, when compared to its industry, is expected to bring better returns to shareholders (Pysh, 2012).
However, Warren Buffett indicated that investors should select businesses with least 14% return on equity (Pysh 2012). Both ANZ and NAB show similar patterns of fluctuation. Before 2008, the ROE for both banks remained higher than 14%, implying that the ratios were healthy and attractive. Over the 5 year, the ROE of ANZ is higher than that of NAB except in 2008, with the highest in 2007 where it peaked at 20. 16%. However, after 2009, the ROE of both banks experienced an upward trend and approached the benchmark of 14%, getting close to safety. In 2011, ANZ’s ROE managed to exceed 14% and reached 14. 93%, which lifts it into the safe zone. Yet, NAB’s ROE remains under 14%, making it less attractive to investors.
In general, ANZ consistently generated a higher ROE than NAB with an average ROE of 14. 57% as compared NAB’s 12. 82%. 3) Capital Adequacy Ratio (CAR) Australian banks are required to maintain a minimum ratio of total eligible capital to total risk-weighted assets of 8. 0%, of which a minimum of 4. 0% must be held in Tier 1(find definition in Appendix) capital in Basel I (APRA, 1999) and 7% must be held in Basel II(Davis, 2010). Both banks had more than the minimum 4% and were consistently over 6% for the past 5 years. As Basel II (find definition in Appendix) was only implemented in 2008, both banks had more than the minimum 7%. Over the 5 years, there is an upward trend of both banks increasing their capital adequacy ratio.
However, it can be observed that ANZ’s ratio increased steeply from 2008 to 2009, while dropping slightly in 2010 and increased again in 2011. For NAB, the ratio had been consistently increasing, with 2009 and 2010 ratios been almost constant and rising again in 2011. The big increment in 2009 for both banks might be due to recovery from the financial crisis and both banks discovered the need to have more capital. The tapered growth thereafter might be due to confidence that the environment is slightly more stable and yet there is still a need to have more capital in case there’s another ‘depression’ due to the potential risks from the complexity of various forms of financial derivatives. 4) Dividend Yield Ratio
Investors usually look for an investment with both a high and stable dividend yield because this means they will be able to recover their money quicker (Review, 2011). A high dividend yield may mean that the investment is undervalued and considered cheap (Investopedia) while a lower dividend yield may mean that the stock is overvalued where investor sentiment is positive about future prospects (Marshall). In the past four years, NAB’s dividend yield exceeded ANZ’s and therefore would get the preference vote of investors. However, share price of NAB has fallen from $39. 71 in 2007 to $22. 37 in 2011, which represents a 43. 67% drop in share value. For ANZ, the share price has fallen from $29. 70 in 2007 to $19. 52 in 2011, a 34. 28% drop in share value.
While investors might prefer a high dividend yield, it is worth noting that NAB’s share price has dropped faster than ANZ’s share price and this could mean that investors value ANZ a better prospect than NAB. Therefore, we can ascertain that ANZ represents a better investment prospect based on dividend yield and the share price analysis. 5) Weighted Average Cost of Capital (WACC) [pic] WACC is considered as the minimum rate of return that the banks need to earn for their shareholders. Hence, value in the company is being eroded when ROA is lower than the WACC. Essentially, this means that for every dollar the banks borrows (debt) or receives from shareholders (equity) is not being recovered from projects that are providing positive net present values. In 2007, ANZ’s WACC is higher than its ROA.
At 2008, both ANZ’s and NAB’s WACC dipped below the ROAs, which is desirable. In 2009, WACC of both banks increased at a relatively higher rate, with NAB overtaking ANZ. This implies that both banks are at higher risk, especially NAB. Despite this, from 2010, WACC of both banks dropped to a relatively low level. However, WACC levels for both banks are still higher than the respective ROAs. Part B Discussion The capital adequacy ratio (CAR) allows one to determine the amount of risk-weighted asset. ANZ had increased amount of risk-weighted asset while Tier 1 ratio increased. This means that growth rate of the core capital is bigger than the growth rate of the risk-weighted assets.
In contrast, NAB had almost same amount of risk-weighted asset with increasing number of Tier 1 ratio, which means that the NAB’s rate of increase of core capital is not bigger than ANZ’s rate of increase of Tier 1 capital. Thus, with ANZ having a higher rate of Tier 1 capital than NAB, it brings about higher stability (Davis, 2010). Despite this, ANZ might be less profitable than NAB as ANZ focuses more on holding core capital. Hence, the choice now depends on risk appetite of the investor, as both banks are relatively stable. The group will now look at other ratios to help determine which bank to invest in. In 2007 and 2008, NAB is considered a better performer as it can recover cost through its projects.
ANZ only managed to recover its cost in 2008. However, from 2009 to 2011, both companies had undesirable performances, as the WACC values are higher than their ROA. Although the fluctuation of NAB’s WACC in 2008 to 2009 varied relatively highly, NAB had performed better than ANZ through the analysis of accumulated differences between the company’s WACC and ROA percentages (ROA – WACC) over a 5- year period from 2007 to 2011. NAB gave a figure of -7. 3% versus ANZ’s -10. 0%. However, ANZ’s overall performance on ROE is better than NAB as it displays relatively higher ratios than NAB. Its drop during the financial crisis is also relatively lower at 3. 98% as compared to NAB at 4. 85%.
Hence, ANZ is more stable and better at employing investors’ capital to generate profits. Moreover, ANZ has less fluctuation in P/E ratio and relatively lower ratio as compared to NAB. This indicates that ANZ is of better value and the company will take less time to generate earnings equivalent to the current share price. In addition, although dividend yield of both banks are increasing gradually, the increment was not for the same reason. NAB’s dividend yield is increasing due a greater drop in share price while ANZ’s dividend yield is increasing due to better dividend payment. With ANZ having a lower P/E based on current earnings and a relatively high dividend yield and high ROE, we expect ANZ to give investor better returns.
This is further supported by the company’s growing exposure to the growing Asian region in recent years, which leads to a higher WACC ratio. It also has lower exposure to the slowing domestic market. References APRA 1999. Capital Adequacy of Banks. Australian Prudential Regulation Authority Policy, Research and Consulting Division. ASR Lesson : Price to Earnings Ratios (P/E). Australian Stock Report, Category: Fundamental Analysis. DAVIS, K. 2010. Bank Capital Adequacy: Where to Now? Australian Centre for Financial Studies. FORBES 2012. Why Return-on-Equity Often Misleads Investors These Days: Dell Better than Apple? Forbes. INVESTOPEDIA Return On Assets. INVESTOPEDIA, Formulas.
INVESTOPEDIA Value Stock. Investopedia- Stocks. INVESTOPEDIA Weighted Average Cost Of Capital Investopedia, Formulas. LARSEN, K. 2012. A Primer on Correlation. The Brigus Group. LIXI 2008. NAB, ANZ deliver the bad news. Australian Banking and Finance, 17. MARSHALL, M. , VAN RHYN, MCMANUS AND VIELE 2010. Accounting: What the numbers mean, McGraw Hill. PHAN, P. 2011. Using the price earnings ratio to pick ASX winners and losers. The Motley Fool. PYSH 2012. What Is Return on Equity and Why Does Warren Buffett Like It So Much? , . Ezine articles, PG REVIEW, F. 2011. How to pick high-dividend stocks. Financial Review: Smart Investor. Appendices 1) P/E Ratio Year |2011 |2010 |2009 |2008 |2007 | |Denomination |$ |$ |$ |$ |$ | |Company |ANZ |NAB |ANZ |NAB |ANZ | |Denomination |$ |$ |$ |$ |$ | |Company |ANZ |NAB |ANZ |NAB |ANZ | |Denomination |$m |$m |$m |$m |$m | |Company |ANZ |NAB |ANZ |NAB |ANZ | |Denomination |$ |$ |$ |$ |$ | Company |ANZ |NAB |ANZ |NAB |ANZ |NAB |ANZ |NAB |ANZ |NAB | |Dividend per share |1. 40 |1. 62 |1. 26 |1. 47 |1. 02 |1. 0 |1. 36 |1. 92 |1. 36 |1. 71 | |Market price per share (at year end) |19. 52 |22. 37 |23. 68 |25. 34 |24. 39 |30. 76 |18. 75 |24. 26 |29. 70 |39. 71 | |Dividend yield (%) |7. 17 |7. 24 |5. 32 |5. 80 |4. 18 |5. 53 |7. 25 |7. 91 |4. 58 |4. 31 | |Dividend Yield = (Dividend per share/market price per share) * 100 5) Weighted Average Cost of Capital (WACC) (a) ANZ (b) NAB Capital, for supervisory purposes, is considered in two tiers. The first accord was the Basel I. It was issued in 1988 and focused mainly on credit risk by creating a bank asset classification system. This classification system grouped a bank’s assets into five risk categories: % – cash, central bank and government debt and any OECD government debt 0%, 10%, 20% or 50% – public sector debt 20% – development bank debt, OECD bank debt, OECD securities firm debt, non-OECD bank debt (under one year maturity) and non-OECD public sector debt, cash in collection 50% – residential mortgages 100% – private sector debt, non-OECD bank debt (maturity over a year), real estate, plant and equipment, capital instruments issued at other banks The bank must maintain capital (Tier 1 and Tier 2) equal to at least 8% of its risk-weighted assets. For example, if a bank has risk-weighted assets of $100 million, it is required to maintain capital of at least $8 million. (Source: Investopedia)
Basel II is the second of the Basel Committee on Bank Supervision’s recommendations, and unlike the first accord, Basel I, where focus was mainly on credit risk, the purpose of Basel II was to create standards and regulations on how much capital financial institution must have put aside. Banks need to put aside capital to reduce the risks associated with its investing and lending practices. (Source: Investopedia) ———————– Figure 1. P/E Ratio Figure 2. ROE Figure 3. Capital Adequacy Ratio Figure 4. Dividend Yield Ratio ———————– BUSM 4154 Accounting hiX¤hSDDB*OJQJphO?? hiX¤h? 6TB*OJQJphO?? h? 6TB*CJ OJQJaJ phO?? %hiX¤h? 6TB*CJ OJQJaJ phO?? h[? ]yB*CJ OJQJaJ phO?? hiX¤h? 6TCJ0OJPJQJaJ0haaoOJPJQJ! hiX¤hSDDB*OJPJQJphO?? )hiX¤h? 6TB*CJ`OJPJQJaJ`phO??! hiX¤h? 6TB*OJPJQJphO?? hiX¤hSDDOJQJh PAGE * MERGEFORMAT i BUSM 4154 Accounting 6