How Royal Bank of Scotland Measures Up As a GARP Investment

LONDON -- A popular way to dig out reasonably priced stocks with robust growth potential is through the "Growth At A Reasonable Price," or GARP, strategy. This theory uses the price-to-earnings to growth (PEG) ratio to show how a share's price weighs up in relation to its near-term growth prospects -- a reading below 1 is generally considered decent value for money.

Today I am looking at Royal Bank of Scotland  (LSE: RBS  ) (NYSE: RBS  ) to see how it measures up.

What are Royal Bank of Scotland's earnings expected to do?

  2013 2014
EPS Growth 245% 46%
P/E Ratio 14.5 10
PEG Ratio 0.1 0.2

Source: Digital Look.

City analysts expect Royal Bank of Scotland to glide back to strong earnings growth both this year and next, the institution recovering strongly following the turbulence related to the 2008-2009 financial crisis, which led to its part-nationalisation.

The bank's explosive earnings projections marks it out as an excellent value pick in terms of estimated PEG rating for both this year and next. As well, although the firm's price-to-earnings (P/E) ratio remains above the bargain benchmark of 10 for 2013, this is expected to fall bang in line with the gauge next year. Any reading around 10 represents excellent bang for your buck.

Does Royal Bank of Scotland provide decent value against its rivals?

  FTSE 100 Banks
Prospective P/E Ratio 14.7 42.1
Prospective PEG Ratio 4.5 0.9

Source: Digital Look.

Royal Bank of Scotland comfortably beats the averages for both the FTSE 100 and banking sector when considering forward PEG projections, even though its banking peers also provide decent value with a readout below the watermark of 1. And on a P/E rating basis, Royal Bank of Scotland also surpasses both groups, particularly the rest of the banking sector.

Myriad question marks continue to loom large
At first glance, Royal Bank of Scotland appears to be a great contender for those seeking attractive GARP stocks. Still, I believe the bank comes attached with a risk profile that may be too hot for many investors. Questions continue to roll in over the threat of fresh legal action related to its previous PPI mis-selling, as well as the company's maligned 2008 rights issue.

Meanwhile, the timing of any potential sale of the government's 84% holding in the bank continues to overshadow the investment case. Investors should watch Chancellor George Osborne's Mansion House speech on Wednesday, which should cast some light on the future of the bank.

The question of privatization led to the exit of chief executive Stephen Hester last week, according to chairman Sir Philip Hampton, who cited "Treasury involvement" in the decision. Hester -- who played a key part in the restructuring of the group -- is expected to leave by the end of the year, prompting much uncertainty over the direction of the bank moving forward.

Royal Bank of Scotland's May interims showed that the bank had surged back into the black in the first quarter, punching pre-tax profit of £826 million against a pre-tax loss of £1.5 billion in the first three months of 2012. But falling profitability at the core -- profits from its U.K. Retail and U.K. Corporate divisions slumped 63% in quarter one -- casts a shadow over whether the bank can keep its financial resurgence on track.

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