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Is It a Good Time to Buy Bank Stocks Now?

Banks have certainly done well over the past two years. Favourable macro-economic conditions have led to growth in almost every business segment of the three main banks in Singapore, which are DBS Group Holdings Ltd (SGX: D05), Oversea-Chinese Banking Corp Limited (SGX: O39), and United Overseas Bank Ltd (SGX: U11).

With net interest margins (the difference between a bank’s cost of capital, and the interest it earns from its loans) expected to rise further, banks are expected to continue to do well in 2018 and beyond.

However, the stock prices of the three Singapore banks have also increased dramatically over the last two years. In that period, DBS, OCBC, and UOB have seen their stock prices climb by 97%, 57%, and 67%, respectively.

This has certainly made investors think twice about whether the trio of local banks, at their current prices, still pose value to investors. With this in mind, I thought it would be a good time to take a quick look at a key valuation metric that will provide investors with more perspective on whether the bank stocks are still worth buying at current prices.

Price-to-earnings ratio

The price-to-earnings (PE) ratio is the main valuation metric that I use to determine whether a bank is cheap or expensive. Mathematically, it is calculated by dividing a bank’s share price by its earnings per share.

Right now, DBS, OCBC, and UOB have stock prices of S$28.88, S$13.09, and S$29.35, respectively. Based on their earnings per share over the last 12 months, these prices translate to PE ratios of 16.45, 13.56, and 15.06. On average, the banks have a PE ratio of 15.02.

Turning back the clock

However, looking at the current PE ratio in isolation will not provide much information. It is important to also take a look at the past to see how the banks were valued before.

For this exercise, let’s take a quick snapshot at valuations in 2008 and 2016. In 2016, the banks were being sold down by the market due to fears of their exposure to the under-performing oil and gas sector. As the three banks stocks have risen considerably since then, their prices in 2016 were very cheap. On the flip side, back in 2008, just before the Great Financial Crisis, the three banks were trading at high PE ratios.

The valuations from 2008 and 2016 will thus give us a better gauge on whether the current PE ratios for the three banks are considered high or low.

In 2016, DBS, OCBC, and UOB had earnings per share of S$1.21, S$0.62, and S$1.44. At that time, their shares were trading at S$15.54, S$8.33, and S$17.79, respectively, which equate to PE ratios of 12.84, 13.83, and 12.35. These PE ratios give an average of 13.0. Based on the average, the banks are trading at a premium now, compared to in 2016.

On the flipside, in 2008, just before the financial crisis, DBS, OCBC and UOB had earnings per share of S$1.22, S$0.546, and S$1.25, respectively. However, their share prices at the peak were at S$24.20, S$9.26, and S$23.10, and translates to PE ratios of 19.8, 16.95, and 18.48. These earnings multiples have an average of 18.4.

Given the current average PE ratio of 15.02 for the banks (calculated above), the current stock prices of the three banks are by no means as expensive as they were back in 2008.

What can drive prices up?

Despite the fact that the three banks in Singapore are certainly not as cheap as they used to be back in 2016, their stock prices are also not as unreasonably priced as they were in 2008. However, one thing that the PE ratio cannot account for is the overall macro-economic conditions the banks were in in 2008, 2016, and today, and the banks’ current earnings growth potential.

DBS, OCBC, and UOB are expected to continue building on their strong showing over the past two years due to a number of reasons. Firstly, their net interest margins, as mentioned earlier, are expected to rise further this year, which will have a multiplier effect on the income earned from the loans they make.

Secondly, loan volumes are expected to increase as overall positive regional economic growth, and a pick-up in the local property sector, will likely drive loan demand.

Thirdly, technological enhancements will continue to improve the cost-efficiency of the banks in Singapore, which will lead to more of their income being filtered down to their bottom lines.

Fourthly, fee and commission income, which is a high margin income stream with low capital requirements, has seen tremendous growth over the preceding quarters for all three banks. If the trend continues, it will help diversify the banks’ revenue streams and increase their overall profitability.

The Foolish conclusion

With bank stocks surging over the past two years, it is unsurprising that many investors are cautious about adding bank stocks to their portfolios. But as demonstrated above, the three main banks in Singapore are still relatively cheap as compared to 2008, and continue to have forward momentum in their businesses.

With the positive outlook, I believe that bank stocks, even at current valuations, can continue to pose good value to investors over the next few years.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore has a recommendation on DBS Group Holdings and United Overseas Bank. Motley Fool Singapore contributor Jeremy Chia owns shares in DBS Group Holdings.