It has been an incredible few years for shareholders in Natwest (LSE: NWG). I owned some Natwest shares at some point during the last five years, but sold them. That means that I have missed out on much of the 405% gain in Natwest shares seen over the past five years.
Normally, when a long-established company in a mature industry quintuples in value over five years, it may start to look overvalued.
But is that the case with Natwest? The dividend yield of 4.7% is well above the FTSE 100 average. Meanwhile, the shares sell for around nine times earnings. That does not look like a very demanding valuation.
Selling for roughly what its asset base is worth
That said, a price-to-earnings ratio is only one way to value bank shares – and not one that everybody uses.
Many investors prefer to look at the price relative to the bank’s book value.
Currently, Natwest is selling for almost exactly its book value. In other words, it can be seen as fairly valued.
Then again, maybe it deserves a higher valuation. As well as the book value of its assets, Natwest has a number of attractive business elements, from strong brands to a large customer base.
Still, even taking those into account, now that Natwest shares are trading for roughly the bank’s book value, I do not expect anything like the sort of price movement in the coming five years that we saw in the past five.
Valuation partly depends on the wider economy
However, there is always a concern when looking at a bank’s book value – it can change, sometimes rapidly.
If the economy weakens and more borrowers default on loans such as mortgages, Natwest’s assets could turn out to be worth less than they are carried for on its books.
The same is true for other banks. However, as Natwest currently sells for the same as its book value, there is limited room for the share price to soak up any such possible revaluation. If asset values fall substantially, I expect the shares could decline.
Natwest continues to perform well
For now, that risk is not top of mind for many investors.
In the first half, the bank reported that profit was up by a fifth. That is an impressive performance and helps explain why Natwest shares have continued to perform strongly. They are up 31% so far this year.
Total impairment provisions moved up, from £3.5bn to £3.7bn. Although that could suggest an expectation of higher defaults, the growth remains fairly modest in absolute terms, especially considering that Natwest was including a charge related to a loan book acquired from Sainsbury, over which it had had no control when the loans were made.
Overall, I am impressed at how Natwest is performing as a business. If it keeps doing well, I think the shares could move up even further from here.
But the economy continues to look fragile and consumer confidence is weak. I remain concerned about the short- to medium-term economic outlook and what it could mean for loan defaults. So I will not be buying Natwest for my ISA.
