If I had a dollar every time someone asks me if bank shares are a buy, I could be a very rich man.
For some context, two decades ago, DBS shares were changing hands at around S$14 a pop. Four years later, they had dropped to around S$7 a share.
It would seem that the great financial crisis of 2008 took no prisoners. It did not really matter which bank you were invested in. If you were a bank, you got hammered badly.
I can still remember a UK television chat show that I took part in at the time.
I was thrown into the deep end with an elderly private investor who had invested heavily in banks because he had thought that they would be safe. He claimed that he held a diversified portfolio. But it was a diversified portfolio that comprised only bank shares.
And therein lies the problem. There is nothing intrinsically wrong with investing in banks. But bank shares should be part of a diversified portfolio that comprises other counters, too.
What’s more, a heavy weighting of banks within a portfolio could be considered unnecessarily risky.
How have banks performed
Let’s look at how banks have performed in the aftermath of the great financial crisis. In a word, pedestrian.
DBS’ shares did recover. The shares climbed from a low of S$6.72 to S$18 in 2015. In other words, they more than doubled, which would have delighted investors who had been brave enough at the time to take the plunge.
The shares then fluctuated between a high of S$27 and a low of around S$17, until the Covid pandemic took its toll on many risk assets.
Following the pandemic, shares in Singapore’s largest bank climbed almost exponentially.
DBS (SGX: D05) shares are now around S$75. They have even been within touching distance of S$80. But it has been a rollercoaster ride since 2005.
With bank shares now at or near their all-time highs, it is fair to ask how much higher they can possibly rise.
For many investors who already own bank shares, it is not unreasonable to assume that their portfolios could be somewhat skewed in the direction of financials.
Those who don’t have any exposure to bank shares could feel that they might have missed out on the thrilling journey. They could hold the key.
Wall of worry
Point is, bank shares could continue to rise until the last remaining sceptic has bought into the lenders.
When there are no more buyers available, then we can conclude that bank shares might have peaked. That is not to say that they have reached a top, forever. Provided banks can continue to deliver rising profit and rising dividends, then they could continue to be a good long-term investment.
As long as there are still investors who worry if they should be buying bank shares, then it could mean that there is still a pool of sceptics that remain to be converted.
So, bank shares could continue to rise until the wall of worry has been conquered or if their ability to generate higher profits starts to deteriorate.
The best time to buy
But that still doesn’t address the question of when to buy bank shares. Probably the best time to buy banks is when their market value is below their net asset value. It doesn’t happen often. But when it does, it could indicate that their shares are undervalued.
In the case of DBS, it happened around the time when the dotcom bubble burst. It happened again in 2008 during the great financial crisis.
Today, DBS shares are valued at about 2.3 times its book value.
Another good indicator could be the price-to-earnings (PE) ratio. It is a measure of how much we are paying for every dollar of profit that a bank makes.
When bank shares are trading at below 10 times earnings, then it could indicate that they are ostensibly cheap.
In the case of DBS, it has only happened a handful of times in the last 20 years. During the great financial crisis, we could buy DBS shares at around seven times earnings. Today, we are paying S$18 for every dollar of profit that the bank makes.
We need to bear in mind that the price of a share is made up of the product of the PE ratio and earnings per share. The first reflects market sentiment. The second is how a bank performs.
Over the last few years, the share prices of banks have been driven by a combination of a rising PE ratio and rising earnings. This combination can be a strong driver of share prices.
At a PE ratio of 18, we could conclude that the valuation of banks is looking stretched. But provided banks can continue to deliver higher profits in the future, it is possible that their share prices could continue to be underpinned by earnings growth.
But as to what might happen to the PE ratio is anyone’s guess. It does not take much to put a dent into market sentiment.
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