Please ensure Javascript is enabled for purposes of website accessibility

Are Australian Banks a Good Investment?

By Motley Fool Staff – Oct 17, 2016 at 6:04AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Australian banks are richly valued, but are they worth buying?

Joe Magyer, the chief investment officer of Lakehouse Capital in Australia, joins Gaby Lapera to talk about Australian banks and real estate. Property is expensive, banks are highly leveraged, and they have unusually high valuations considering a few potential risk factors. They also chat about how to buy Australian stocks or funds. Watch this segment of Industry Focus: Financials to learn more.

A full transcript follows the video.

A secret billion-dollar stock opportunity
The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early in-the-know investors! To be one of them, just click here.

This podcast was recorded on Sept. 15, 2016.

Joe Magyer: Up until recently, Australian banks where the most expensive banks in the world. They're still very expensive. Why are they so expensive? Well, default rates have been incredibly low in Australia. The country hasn't had a recession in 25 years. Just think about that. To an American, you're like, "What?! 25 years? That's crazy!" It's almost the longest streak ever. Australians have a lot of confidence as a result of this. Just imagine how different your life perspective would be if you had not seen a recession. You have professional investors who are in their early 40s who have not seen a recession. It's a very different worldview.

Gaby Lapera: That's so wild.

Magyer: Yeah. So, I think the banks tend to make loans with a little bit more of an optimistic view than American banks do, and investors tend to value them a little bit more optimistically. So, I'm actually rather bearish on the Australian banks. It's not because I'm expecting some cataclysmic event. But there are a few things. One, net interest margins are getting squeezed -- to get back to that thing I was saying you shouldn't pay too much attention to before. Default rates are near record lows. They won't stay that way. I don't know when exactly they'll pop, but they won't stay that way. The banks are also paying up around 75% of their income as dividends, which does not leave...

Lapera: 75%?

Magyer: Yeah. The yields are huge, and everybody loves that and gets excited about it. But that doesn't leave much room for error, when you're levered 15:1. All you need is a slight down-tip in your profit. When you magnify that, there won't be a lot of gravy left over for dividends.

Lapera: Yeah. If they're smart, they'll cut their dividend instead of trying to hold on. Is the real estate market substantially different than it is here? I realize, at the center of the country...

Magyer: No one is there.

Lapera: No one super-duper lives there. Like some kangaroos. But is it a lot tighter as a result? Is housing super expensive? Is it D.C. levels or Iowa levels? Or is it somewhere in between?

Magyer: It's regional, but overall, it's very expensive. There was some work done by Jonathan Tepper and John Hempton in the past year, a couple of hedge fund managers. They went around and basically pretended to be interested in buying homes, and went to dozens of different banks to see what they could get lent. One bank was willing to lend them -- they were posing as a couple -- 10 times their income to buy a home. That's lofty. I personally don't think I could afford a mortgage that's 10 times my income, or buy a property that's 10 times my income. I just think, overall, it's not as extreme as the U.S. was in terms of loose lending standards, overall. No doc loans, or NINJA loans -- no income, no job -- those aren't really existing in Australia.

Still, prices are high, just like we saw with the dot-com bubble. Just because assets are freely traded, and there's nothing illegal going on doesn't mean an asset can't get overvalued. I think there's probably risk in the Australian property market today. If you're buying Australian property with a five- to 10-year residential viewpoint, it's not something I would stress about. But there's a lot of people -- something like one in seven Australians -- own an investment property. Which is a crazy concept in America. I certainly don't know one in seven people that own an investment property. And most of those are what's called negatively geared. That basically means they're losing money on a cash flow basis month to month in anticipation of getting it back in capital gains. (laughs) When I heard that, I was like, whoa! That's a pretty foreign concept to American property investment as well.

Lapera: I mean, the things you're describing, while they're not quite as bad as they were during the financial crisis, are things that were happening during the pre-financial crisis.

Magyer: Yes. I remember, back then, it seemed like a surprising number of my friends were budding real estate moguls. And I was like, "Actually, no ... " It just seemed odd, at the time. Anyway. Overall, I think property is expensive, and there's some risk there to be mindful of. If you're thinking about buying the banks, which are super levered to that and don't have much wiggle room with their payouts, and rich valuations. So, overall, I'm not predicting a crash, I'm just saying that I think the banks are basically priced as though everything will stay great. But there are many ways to lose. And I try to avoid situations like that.

Lapera: Fair enough. I think our listeners will have one question after hearing all that. Not that they're going to go out and buy Australian banks, but, is there a way for U.S. investors to buy Australian stocks?

Magyer: Yes. You can do it directly. You can also look at Australian funds. It should be clear that I'm not actively touting our fund, which doesn't even exist yet. I'm just saying, broadly speaking, you can look at active management. You can also look at ETFs. The trouble with ETFs in Australia, though, is that the market is super top-heavy. There's the big banks, a couple big retailers, and commodity companies. Something like 10 companies make up almost half of the index. There's another 2,000 that make up the other half.

Among those, you've got companies that don't look anything like the big players. There're a lot of small, fast-growing software companies that are deeply profitable, strong recurring revenue, great balance sheets. Those are the kinds of things I get into. So, you could look for active management, but to be honest, it's kind of difficult, straight up. You could go direct, but active management, you would want to find a fund that's based here in the U.S. so you could make the investment. It's hard to invest in funds that are based outside of America, because then you run into what's called PFIC rules. That's a long story short.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.