Shares in FTSE 100 ‘Big Four’ bank NatWest (LSE:NWG) have jumped 97% from their 26 February one-year high of £2.30.
Some investors might think the stock cannot keep rising after such gains, so avoid it. Others may see the price momentum as unstoppable, so buy it.
As a former investment bank trader and longstanding private investor, I think neither view is conducive to optimising investment returns. My key question on a stock’s price is whether there is any value left. I am also interested in the added yield income it could provide me.
Is there value left in the stock?
My starting point in assessing whether NatWest’s price fairly reflects the bank’s value is comparing valuation with its competitors. On the price-to-earnings ratio, it currently trades at 7.8 compared to its peer group average of 8.4. That is bottom of the group that comprises Barclays (at 8), Standard Chartered (8.4), HSBC (8.5) and Lloyds (8.7). So it looks a major bargain on this basis.
However, on the price-to-book ratio, NatWest is presently at 0.9 against a competitor average of 0.8. So it looks slightly overvalued on this measure. And the same applies to its 2.4 price-to-sales ratio compared to the 2.2 average of its peers.
The second part of my price evaluation process assesses where a stock should be, based on future cash flow forecasts.
Using other analysts’ figures and my own, the resulting discounted cash flow analysis shows NatWest shares are 53% undervalued at £4.52. Therefore, their fair value is technically £9.62. They may be driven lower or higher than this by market forces, of course.
There are currently several very undervalued stocks in the FTSE 100, according to my analysis. However, NatWest’s DCF underlines to me that it is one of the most undervalued right now.
How does the yield look?
In its 14 February full-year 2024 results, NatWest increased its annual dividend by 26% to 21.5p a share. This gives a yield of 4.7% on its current £4.52 share price, against the FTSE 100’s 3.5% average.
So investors considering a £10,000 stake in the bank would make £5,985 dividend income after 10 years and £30,847 after 30 years. These numbers are based on the current 4.7% average yield and on the dividends being reinvested back into the stock (dividend compounding).
That said, analysts forecast the bank’s yield will rise to 5.4% in 2025, 6.1% in 2026, and 6.9% in 2027.
How does the core business look?
A key risk to the bank remains a continued decline in UK interest rates, I think. This could weigh on its net interest income (NII), which is the difference in interest made between loans and deposits.
However, its 2024 results saw national investment income (NII) increase 2% year on year to £11.275bn. This helped drive profit up 3.9% to £4.811bn.
Consensus analysts’ forecasts are that NatWest’s earnings will rise 1.5% a year to end-2027. And it is ultimately this growth that drives a firm’s share price and dividend higher, over time.
Given this and its already very undervalued share price and good yield, I will be buying more of the shares very soon.
