Image source: NatWest Group plc
Imagine being able to buy pound coins for just under 64p each at the start of the year – and getting paid to hold them! That's exactly what has happened with a FTSE 100 Index It's up 57% year-to-date and has an annual dividend yield of 5.1% to boot!
Now, stocks are different from currencies. This particular stock has risen in value this year, but that doesn't mean it will continue to do so. It could fall, or it could continue to rise, adding to the 73% gain shareholders have enjoyed over the past five years.
Bank on main street with lots of things to choose from
The company in question is familiar to most of us: NatWest (LSE: NWG).
NatWest owns the eponymous bank and also operates under other brands, including Royal Bank of Scotland and Ulster Bank.
I think it has a lot of positives. It has strong brand recognition, a large customer base, strong earnings and should benefit from resilient long-term demand for financial services.
Why are stocks valued like this?
Given those strengths (which in my view were as obvious in January as they are now), why has the stock soared and why is it still trading at a seemingly low valuation of 7.3 times earnings?
NatWest is not the only bank that currently has a rather low price-to-earnings ratio. Lloyds sells for eight times earnings and Barclays for 9.
I think these valuations reflect the perceived risks of an uncertain economy. If that leads to a weaker housing market and rising loan defaults, bank profits could fall. NatWest's first-half profit from continuing operations was 12% lower than the same period last year.
But here is the less obvious point. If price-earnings ratios are still quite low because banks are still seen as risky, why has NatWest's value risen by more than half so far this year? Are investors ignoring the risks?
One explanation is that as the government has continued to sell its stake (a remnant of the bailout during the financial crisis), the City has paid more attention to the business's fundamentals and valuation. It previously looked cheap and has been shelling out large amounts of cash.
Even after the share price rise this year (greater than the 22% and 47% seen at Lloyds and Barclays respectively), its price-earnings ratio remains lower than both.
Could things get any better?
Still, as other bank price increases suggest, investors have been drawn to the sector this year.
Fears of a severe economic downturn have not yet materialised, so the risk discount on shares has narrowed and their prices have risen. They could continue to rise from now on.
Still, I remain concerned about the health of the global economy. U.S. economic indicators suggest the world's largest economy may be struggling. I fear what that could ultimately mean for bank stocks on both sides of the pond.
For now, I have no plans to buy NatWest or any of its FTSE 100 banking peers.
