FTSE 100 bank NatWest (LSE: NWG) looks much more undervalued to me than the 7% it has lost from its £3.72 12-month traded high.
My first step when assessing this is to look at key relative stock valuation measures, beginning with the price-to-earnings ratio (P/E).
The ‘Big Four’ bank currently trades at a P/E of 6.74. It is bottom of its competitor group, which has an average P/E of 7.9.
This comprises HSBC at 7.2, Lloyds at 7.9, and both Barclays and Standard Chartered at 8.2. So, it certainly looks cheap on that basis.
To find out what that means in cash terms, I ran a discounted cash flow. This shows NatWest shares to be 57% undervalued at their present price of £3.46. Therefore, a fair value for the stock is £8.05.
It might go lower or higher than that, given the vagaries of the market. But it underlines to me that it looks one of the best bargains in the FTSE 100 right now.
Business outlook
The primary risk for NatWest is a declining net interest margin. This is the difference between the rate it receives on loans and the rate it pays on deposits. It is expected to fall in line with interest rate reductions in the UK.
Despite this, NatWest’s H1 2024 results released on 26 July showed Q2 profit 26.8% higher than Q1’s, at £1.252bn versus £987m. And it still delivered an operating profit of £3bn+, with a return on tangible equity of 16.4%.
In any event, interest rates go up and down in regular cycles. So for long-term investors, the effects of these changes should even out over time, in my experience.
The bonus of a high dividend
Enhancing NatWest’s appeal to me is the high dividend yield it provides. In 2023, it paid a total of 17p a share, giving a return of 4.9%.
So, £11,000 (the average UK savings amount) invested at that rate would generate £539 of dividends in year one. After 10 years on the same average yield it would be £5,390, and after 30 years £16,170.
That said, much more could be made if the dividends were used to buy more NatWest stock.
Doing this (‘dividend compounding’) on the same average yield would produce an extra £6,938 after 10 years, not £5,390. And after 30 years on the same basis, an additional £36,699 in dividends would have been made, rather than £16,170.
At that point, the total investment would be worth £47,699 and would pay £2,337 a year in dividends!
Increased dividend forecasts
This year, it increased its interim dividend by 9%, to 6p from 5.5p. If this were applied to the entire dividend then the total this year would be 18.53p. It would give a yield of 5.4% on the current £3.46 share price.
Analysts forecast that the payout will rise to 18.9p in 2025 and to 21.2p in 2026. These would generate respective yields in those years of 5.5% and 6.1% based on the present share price.
My overall view on the stock
I already hold shares in NatWest, based on their growth prospects, undervaluation, and good yield.
As each of these factors is still in place, I will be adding to my holding very soon.
