FTSE 100 ‘Big Four’ bank NatWest (LSE: NWG) has dropped 13% since its 29 July 12-month high of £3.72.
This is no surprise to me, given the cut in benchmark UK interest rates announced on 1 August. The first such reduction since March 2020 highlights the key risk for NatWest of lower margins between deposits and loans.
That said, the price drop adds to what was already an extreme undervaluation in the shares, in my view. In short, I think they look like a terrific bargain now.
How undervalued are the shares?
A key measurement I use to quickly gauge whether a stock is relatively undervalued is the price-to-earnings ratio (P/E).
NatWest is trading at a P/E of 6.4 – bottom of its peer group, which has an average P/E of 7.4. This comprises HSBC at 6.7, Standard Chartered at 7.4, Lloyds at 7.6, and Barclays at 7.8. So, it looks undervalued to me.
But how much exactly in cash terms? A discounted cash flow shows NatWest shares to be to be 58% undervalued at their present price of £3.23.
Therefore, a fair value for them would be £7.69. They may go lower or higher than that, but it highlights to me how much of a bargain the stock appears.
Do growth prospects support a higher valuation?
Earnings are ultimately what drives a share price higher (and dividend payouts too), and NatWest’s potential looks solid to me.
Despite the risk to its interest margins, consensus analysts’ estimates are that its revenues will grow 3.6% a year to end-2026. Earnings per share are expected to rise by 1.5% a year to that point. And return on equity is forecast to be 10.3% by that time.
These look well supported to me by the bank’s H1 2024 results released on 26 July. Its profit did fall by 7.5% from the same period last year, but it still came in at £2.239bn.
Encouraging to me as well was that Q2 2024’s profit was 26.8% better than Q1’s, at £1.252bn versus £987m.
These numbers enabled the bank to increase its interim dividend by 9%, to 6p a share from 5.5p.
Good dividend payouts in the interim
Analysts now estimate that NatWest will provide yields of 5.4%, 5.6%, and 6.3% in 2024, 2025, and 2026, respectively.
In 2023, it paid a total dividend of 17p, which gives a current yield of 5.3%. This compares very favourably to the average FTSE 100 yield of 3.6% and the FTSE 250’s 3.3%.
So, using the current payout level, £10,000 of NatWest shares would generate an extra £6,970 after 10 years. This is based on the same average yield over the period and reinvesting the dividends back into the stock (‘dividend compounding’).
After 30 years on this basis, the investment in the bank would be worth £48,866!
What should I do?
Happily, I already own NatWest shares from a much lower level, so I will keep that position as is.
If I did not have this holding, I would see the stock as too good an opportunity to miss for three reasons. First, its bargain-basement valuation. Second, its solid growth prospects. And third, its very healthy dividend payouts.
