Is Morningstar saying Australian banks are among the best investments in the world?

Morningstar recently looked at Australia’s four big banks and upgraded them to their highest possible classification.*  Given that we recently launched Market Vectors Australian Banks ETF (ASX code: MVB), we were keen to understand how they arrived at their conclusion. 

First, who is Morningstar? Morningstar is one of the world’s big research houses. Founded in Chicago in 1984, its core business is as a global provider of financial research and information. A very important question to ask yourself about any research is whether the researcher has a vested interest in talking up or talking down their subject matter. At the heart of Morningstar’s value proposition is that they are independent. 

The research was done by David Ellis, Morningstar’s head of financial services Asia Pacific.  Interestingly, this is a global analysis. He is ranking the banks against all companies around the world, not just Australian companies.

This is sounding like strong praise from a source that can be trusted. Let’s look closer at exactly what they said, and why they said it.

Morningstar has a different approach to mainstream analysts. They focus on the long term; they focus on a company’s ability to sustain high profits; and they have a fun way of explaining their point of view.

Think of a company you invest in as operating out of a medieval castle. Think of the company’s competitors as the barbarians trying to storm the gate and steal their wealth. What your company needs is a moat. 

If you can remember the last Robin Hood movie you saw, or maybe the last Lord of the Rings movie, you will know that a moat is a ditch dug around the castle to make it hard to get into. Moats were often full of water or sometimes sharp spikes.

Morningstar uses Warren Buffet’s concept of an "economic moat". In simple language they are rating companies on how hard it is for competitors to take business away. Does the company you are investing in have a moat? Is it a "narrow moat" or a "wide moat"?

Morningstar’s recent article said that Australia’s big four banks are four of only five banks anywhere in the world that have a wide moat. In fact, a moat that is:

" … sufficiently wide to ensure global sector-leading returns on equity for the foreseeable future." *     

If you want more analysts’ language, they said:

 "The four major banks dominate a regulated and rational oligopoly, bestowing structural advantages that are strong and durable. This enables the banks to prosper compared with major banks in other global jurisdictions." *  

Morningstar’s website states that they expect:

" … the major Australian banks to exercise sufficient pricing power to protect profits and generate returns substantially in excess of their costs of equity on average for the next 10 years and — more than likely — for the next 20 years." *  

They are suggesting that these banks will continue to make large profits because it is so hard for any competitor to touch them. Morningstar provides a list of reasons for this including efficient scale, cost advantages, strong balance sheets, tight risk management, high credit ratings, intangible assets and switching costs.

Over the next few weeks NAB, ANZ, and Westpac will be reporting earnings for the financial year ending 30 September 2013. Many investors’ eyes are on potential special dividends. With historic dividend yields ranging from 6.8% to 7.6% including franking credits, and with term deposits not yielding much over inflation, many retirees are choosing bank shares to supplement their income.

Maybe the investors attracted to yield haven’t thought about the long term as deeply as Morningstar. Then again, maybe they know these companies well enough as consumers to know that the banks are big and powerful and aren’t going away any time soon.

Morningstar’s proposition is that you want to be investing in companies that aren’t going to be ravaged by competitors. By upgrading their classification to "wide moat", Morningstar is indicating that these Australian banks fit this bill, even judged in a global context. 

As an investor, if you agree with Morningstar, the next question you have to ask: Which bank to invest in? 

Or, you might consider Market Vectors Australian Banks ETF (ASX code: MVB), an efficient and cost effective way to invest in the seven largest Australian banks in one single trade. It is the only ETF in Australia with a focussed exposure to Australia’s largest sector. 

For more information on the Market Vectors Australian Banks ETF issued by Market Vectors Investments Limited, including a copy of the product disclosure statement, click here. 

Link to Morningstar article: "3 big banks, 3 big dividends", dated 15 October 2013