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Value In The Banking Sector

BanksValue investors tend to be quite clear about what they are looking when buying shares.

For instance, not every cheap stock is necessarily a value stock to a value investor. Cheap rubbish is, after, all still rubbish. So, as far as value investors are concerned, the fundamentals should always be favourable too.

An ideal value stock should have a lower than average price-to-earnings ratio and an attractive price-to-book value. It should also exhibit an above-average dividend yield. Additionally, there should also be little or no debt on the balance sheet.

Value stocks can be found almost anywhere – perhaps even amongst the banking sector.

In Singapore there are four listed lenders. They are DBS Group Holdings (SGX: D05), United Overseas Bank (SGX: U11), Oversea-Chinese Banking Corp (SGX: O39) and Hong Leong Finance (SGX: S41).

DBS, OCBC and UOB are all trading at PE ratios below the market average. However, they might not be quite low enough to grab the attention of value investors. Ideally, the PE should be about two-thirds of the market average. So with the market currently valued at roughly 13 times earnings, only shares with a PE of around 8 are likely to make the cut.

Hong Leong almost certainly doesn’t make the grade. Its PE is a whopping 17.

The dividend yields for all four look appealing, especially Hong Leong Finance’s yield of 4.45%. This compares well with market average yield of 2.9%. Interestingly, Hong Leong Finance, which is the only of the four that is not included in the Straits Times Index (SGX: ^STI), is also the only company trading at below its book value.

Closer inspection of Hong Leong Finance shows the company has net cash. This could suggest that the company might be in good financial health. However, whilst shareholders have seen increasing dividends, the company’s earnings per share have been erratic.

For now it may seem as there is little value to be found in the financial sector. But value investors are a patient lot.

For example, whilst DBS is currently trading at around 11 times earnings, this wasn’t the case in 2009 when pessimism over banks was high. At the time, DBS was trading at only 6 times earnings. Its dividend yield was 9% and it was priced at half its book value.

Could that happen again? Value investors almost certainly think it could because history has a habit of repeating itself.