Does Banco Santander SA Pass My Triple-Yield Test?

Like most private investors, I drip-feed money from my earnings into my investment account each month. To stay fully invested, I need to make regular purchases, regardless of the market’s latest gyrations.

santanderHowever, the FTSE 100 is up nearly 90% on its March 2009 low, and the wider market is no longer cheap. It’s getting harder to find shares that meet my criteria for affordability.

In this article, I’m going to run my investing eye over the eurozone’s largest bank, Banco Santander  (LSE: BNC) (NYSE: SAN.US), to see if it might fit the bill.

The triple-yield test

To gauge the affordability of a banking share for my portfolio, I like to look at three key figures –the dividend yield, earnings yield, and return on equity, and compare them to the returns available from alternative assets. I call this my triple-yield test:

Banco Santander Value
Current share price 575p
Dividend yield 8.6%
Earnings yield 5.7%
Return on equity 5.4%
FTSE 100 average dividend yield 2.9%
FTSE 100 earnings yield 5.8%
Instant access cash savings rate 1.2%
UK 10yr govt bond yield 2.6%

A share’s earnings yield is simply the inverse of its P/E ratio, and Santander’s earnings yield of 5.7% reflects a P/E ratio of around 17, which is in-line with the FTSE 100 average.

However, Santander’s big appeal for investors is its massive dividend yield, which is based on a payout of €0.60 per year, that’s remained unchanged since 2008. Most UK shareholders opt to receive this as a scrip dividend [as shares], as this means that the dividend is not subject to Spain’s 21% withholding tax on overseas dividend payments.

As this dividend is paid in euros, its value to UK shareholders varies with the £:€ exchange rate. While Santander’s yield has been as high as 10% in recent years, it’s currently down to 8.7%, thanks to the strong pound.

Diversity makes Santander a buy

For me, two of Santander’s strongest points are its diversity and its reliance on traditional banking — lending and deposit-taking — rather than investment banking.

In 2013, 47% of Santander’s profits came from Latin America, 43% came from Europe, and 10% came from the United States. During the financial crisis, this diversity enabled to offset losses in Europe with profits from Latin America, and rebuild its balance sheet without needing a bailout, or cancelling its dividend.

I rate Santander as a strong long-term buy, and its high yield scores in my test confirm that the bank is profitable and delivers strong shareholder returns.

What about UK banks?

However, now that the financial crisis is over, several UK banks are looking conspicuously cheap — certainly much cheaper than Santander. 

If you're thinking of moving your money from Santander stock into one of the UK banks, I'd urge you to take a look at "The Motley Fool's Guide To Banking" before you make any decision.

This exclusive FREE report from the Fool's banking team compares all the major UK banks using six 'City insider' financial ratios that highlight the true strengths -- and weaknesses -- of each bank.

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Roland does not own shares in Banco Santander.