Should investors like what they see with this bank?
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The National Australia Bank Ltd (ASX: NAB) share price has soared by more than 20% in the last 12 months. With that strong rally, investors may be looking at the ASX bank share as an opportunity that could keep rising.
It’s important to acknowledge that just because bank shares have gone up doesn’t mean they will continue rising. Momentum can help power a share higher for some time, but earnings probably need to justify that rise at some point.
Big ASX bank shares aren’t the type of company that delivers significant earnings growth year after year. So, valuation becomes critical for deciding how high the NAB share price can rise. What price/earnings (P/E) ratio is too high?
What is the valuation?
I believe the current financial year — being the 12 months to 30 September 2025 — is far more important than the past financial year in helping us decide a business’s worth.
According to the projection on Commsec, NAB’s earnings per share (EPS) could climb by a relatively small amount in FY25 to $2.39. At the current NAB share price, that means it’s trading at 16x FY25’s estimated earnings.
This seems pricey, considering the NAB share price traded on an average annual P/E ratio of 14.4x in FY22 and 14.7x in FY19, according to Commsec.
I’d only want to buy NAB shares at a higher earnings multiple if its growth outlook had improved considerably.
My take on NAB shares
The banks talk about how competition for mortgages and deposits is hurting their profit margins, as measured by the net interest margin (NIM). They don’t want to see their lending market share decline, but a drop in profit margins isn’t ideal either.
I don’t know whether anything can truly change this competitive dynamic. Lenders no longer need a national branch network to provide a national service – internet banking and mortgage brokers seem to be a permanent shift. Just look at how institutions such as Macquarie Group Ltd (ASX: MQG) and ING have become sizeable players without a branch network.
Competitors appear willing to accept a lower return on their capital, which highlights how loans have increasingly become commodity products because of brokers and the ability of customers to compare loans online.
I don’t think banks are going to be as profitable in the future as they were in the past, in profit margin terms.
One advantage that NAB has over most competitors is its large business banking operations. This area is not as competitive as retail banking.
However, I wouldn’t choose to buy today at this higher NAB share price valuation. I’d want to see the forward P/E ratio go under 15, and preferably lower, before investing.
Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has positions in and has recommended Macquarie Group. The Motley Fool Australia has positions in and has recommended Macquarie Group. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
