FTSE banking giant NatWest (LSE: NWG) has dipped 5% since its 22 August one-year traded high of £5.65.
Before this, it had been in an unbroken bullish trend since 27 October 2023, when it closed the day at £1.82.
Given this, might now be a good time for me to add to my NatWest holding on a rare dip?
The answer depends on two things. First, whether the stock has significant value left in it after its long bullish streak. And second, how the underlying business’s prospects look.
How undervalued does it look?
Exploiting the difference between a stock’s price and its fair value is the key to major long-term profits in my experience. Prior to my current 30-year stint as a private investor, I spent several years as a senior investment bank trader.
This difference arises from the fact that a share’s price and value are rarely the same thing. Its price is simply whatever the market deems appropriate at any given point. But its value reflects the true worth of the underlying business, based on a range of fundamental factors.
Investors looking to identify and quantify this gap need to get it right. And the best way I have found of doing this is through the discounted cash flow model.
This precisely identifies where any stock should be trading, based on the cash flow forecasts for the underlying business.
In NatWest’s case, it shows the shares are 44% undervalued at their current £5.39 price.
Therefore, their fair value is £9.63.
Another positive element of the DCF is that it is a standalone valuation model. So, it is unaffected by any under- or over-valuations for the sector in which the company operates.
However, there are also secondary confirmations of NatWest’s undervaluation from peer group comparisons.
For instance, its 8.7 price-to-earnings ratio is bottom of its competitor group, which averages 11.1. The banks comprise Barclays at 8.8, Standard Chartered at 10, Lloyds at 12.1, and HSBC at 13.7.
How are the business’s prospects?
The bank returned to full ‘private’ ownership (by its shareholders) on 30 May. This marked the end of its support from the government, following the bailout during the 2007/08 financial crisis.
Its H1 2025 results, released on 25 July, confirmed its strong recovery since that point.
Income jumped 11.9% year on year to £7.985bn, while expenses dropped 1% to £4.018bn. Operating profit before tax leapt 18.4% to £3.585bn, while profit after tax soared 19.5% to £2.675bn.
As a result of these excellent figures, the bank increased its interim dividend by 58% to 9.5p. And it announced a £750m share buyback, which tends to support share price gains.
A risk to future profits is intense competition in the banking sector reducing profit margins.
However, NatWest upgraded its income and returns guidance for this year in the H1 results. The former was increased to more than £16bn from £15.2bn-£15.7bn. And the latter saw a rise in return on tangible equity (ROTE) to more than 16.5% from 15%-16%.
As with return on equity, ROTE is derived by dividing a firm’s net income by average shareholders’ equity. However, ROTE does not include intangible elements such as goodwill.
Given its strong results, upgraded forecasts, and deep under-pricing to fair value, I will buy more of the stock soon.
