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FTSE 100 'Big Four' bank NatWest (LSE: NWG) is down 13% since July 29 at a 12-month high of £3.72.
This comes as no surprise to me, given the UK interest rate cut announced on 1 August. The first such reduction since March 2020 highlights NatWest's significant risk of lower margins between deposits and loans.
That said, the price drop adds to what was already an extreme undervaluation of the stock, in my opinion. In short, I think they look like a bad deal now.
How low are stock prices?
A key metric I use to quickly gauge whether a stock is undervalued is the price-to-earnings (P/E) ratio.
NatWest trades at a P/E of 6.4 – below its peer group, which has a P/E ratio of 7.4. This includes HSBC at 6.7, Standard Chartered in 7.4, Lloyds in 7.6, too Barclays at 7.8. So, it doesn't seem important to me.
But how much is it really in monetary terms? Discounted cash flows show that NatWest shares would be undervalued by 58% at their current price of £3.23.
Therefore, the fair value for them would be £7.69. They could be lower or higher than that, but it highlights to me how much profit is coming from the stock.
Do growth prospects support higher valuations?
Profits are ultimately what drives share price (and dividend payouts), and NatWest's strength looks strong to me.
Despite the risk to its interest margins, analysts' estimates for the deal are that revenue will grow by 3.6% annually until the end of 2026. Earnings per share are expected to increase by 1.5% annually to reach that point. And the return on equity is predicted to be 10.3% during that period.
This appears to be well supported by the bank's H1 2024 results released on 26 July. Its profit fell by 7.5% from the same period last year, but came in at £2.239bn.
Also encouraging is that Q2 2024 profits were 26.8% better than Q1's, at £1.252bn compared to £987m.
The numbers enabled the bank to increase its interim dividend by 9%, to 6p a share from 5.5p.
Good interim dividend payments
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 dividend of 17 %. This compares favorably with the FTSE 100's average yield of 3.6% and FTSE 250It's 3.3%.
So, using the current rate of return, £10,000 of NatWest shares will generate a further £6,970 after 10 years. This is based on the same average income over the period and the reinvestment of dividends in stock ('dividend compounding').
After 30 years on this basis, the investment in the bank will be worth £48,866!
What should I do?
Thankfully, I already own NatWest shares from a very low level, so I'll keep them as they are.
If I didn't have this catch, I would see the stock as a great opportunity to miss for three reasons. First, its bargain-basement valuation. Second, its growth prospects are strong. Third, its very healthy dividend payments.
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