Why I Am Still Bullish on Royal Bank of Scotland

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LONDON -- Shares in Royal Bank of Scotland  (LSE: RBS  ) (NYSE: RBS  )  had a great 2012. So far in 2013, they are down 5.4%. That's pretty disappointing when you consider the fact that the FTSE 100 is up 8.2% in 2013. I welcomed RBS's falls as an opportunity to top up. Here are the three reasons why I did.

1. Sentiment
RBS is probably the most scrutinized company in the FTSE 100. Last week, as the company reported its 2012 results, the shares fell 9%. The results were met by the usual swathe of whining over the cost of government support to the bank and the amount that it pays its staff.

We all remember the days when RBS's long-term future was in jeopardy. The accounting loss reported by RBS seems to have scared some investors into selling, perhaps fearful of possible real cash losses. I took advantage of the tsunami of pessimism to buy more shares at 321 pence.

2. Profit potential
RBS's recent results show just how profitable the bank would be if they can cut out the bad stuff. Like Payment Protection Insurance costs (1.1 billion pounds in 2012), interest rate hedging products compensation (700 million pounds), and regulatory fines (300 million pounds). The bank also lost 5.3 billion pounds on asset impairments.

The good news is that, unless there is more bad news in the pipeline, these fines are unlikely to repeat in 2012. Even impairments are falling sharply: This figure is down from 7.4 billion pounds for 2011.

If RBS can demonstrate profitability, the market will reappraise the shares. 2013 could be the year that RBS finally manages to convince investors that it is back to profitable banking. The next two trading statements will be crucial.

3. Asset backing
RBS's final results revealed that the bank has net tangible assets of 455 pence per share. That's 47.8% ahead of today's share price.

I believe that profitable companies should never trade at a discount to their book value. Furthermore, a profitable firm will be growing its book value. Consensus estimates are for RBS to report 28.1 pence of earnings per share for 2013, to be followed by 36.5 pence for 2013.

A simple analysis suggests that RBS could end 2014 with 500 pence of assets per share. If this does indeed come to pass, RBS bears will be converted to bulls one by one along the way. I expect that RBS shares will end 2013 trading over 400 pence.

Buying shares in an out-of-favor company like RBS can yield big gains if sentiment turns. Contrarian plays are just one way that you could use the stock market to boost your investment returns. For more wealth-building ideas, check out the free Motley Fool report, "10 Steps to Making a Million in the Market." This report is completely free and will be delivered to your inbox immediately. Just click here to get the report today.

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