Is Royal Bank of Scotland Group the Ugliest Stock in Britain?

Should you buy this bailed out British bank that's attempting a turnaround?

Mar 6, 2014 at 7:00AM

Royal Bank of Scotland Group (NYSE:RBS) has destroyed the portfolios of pre-crisis shareholders through massive losses and dilution. But should investors buy today's RBS? As a part of a diversified banking portfolio, RBS could make a good long-term investment for its eventual recovery.

British bank bailout
New York and London both compete aggressively for the activities of financial giants, so it should come as no surprise that as U.S. banks were taking government funds, British banks were doing the same. Of Britain's major publicly traded banks, Lloyds Banking Group (NYSE:LYG) and Royal Bank of Scotland Group both remain partly owned by the government.

But there are critical differences in these two banks now, and these reasons earn Royal Bank of Scotland Group the title of the ugliest of Britain's banks.

A tale of two bailouts
Despite both Lloyds and RBS still having government ownership attached to them, their present situations in this arena are far apart. The current government stake in Lloyds in 33%, down from 39%, and the government is interested in further reducing its stake in the near future.

In contrast, the government still owns 81% of RBS and appears in less of a hurry to sell down this stake. Majority government ownership has made RBS a political football, and has undoubtedly scared off many financial investors.

The earnings picture at RBS shows how the effects of 2008 are still echoing through this financial giant. Shares of RBS fell over 7% last week when the bank posted a 9 billion pound net loss. Furthermore, the future looks gloomy too as the bank projects it could take another three to five years for recovery to take hold.

Much to blame for the massive loss was 3.8 billion pounds of litigation, compliance, and fines, along with a 4.8 billion pound loss stemming from toxic assets as RBS shifted these assets to an internal bad bank. While, the toxic assets losses are unlikely to be as high, litigation and fines still could be major future costs. As a major player in the financial activities preceding the crisis, RBS has potentially exposed itself to large amounts of liability.

RBS vs. peers
With RBS being seen as a ward of the state by many citizens and politicians alike, paying a dividend in the current state would be next to impossible, even if we exclude the poor earnings situation. With only minority government ownership, Lloyds pays no dividend partly for capital preservation ahead of another round of stress tests and partly due to the political nature of the situation.

British bank investors seeking dividends will be more at home with HSBC (NYSE:HSBC) which yields over 5% and brings the stability that comes with positive earnings for the past year and projected positive earnings for this year and next. Even Barclays (NYSE:BCS) offers investors a dividend exceeding the 2% level, along with a lower forward price to earnings ratio than any other major British bank.

Is RBS the best choice?
Owning RBS shares requires a different investing strategy than owning shares of other British banks. While HSBC and Barclays investors can profit from dividends, and Lloyds shareholders could get a boost as the bank is fully reprivatized, RBS shareholders are holding a bank likely to be in majority government hands and facing financial headwinds for the next couple years.

Because of this, RBS fits well into the category of a long-term somewhat speculative value play. The upside in this company can be seen in the long-term through a move closer to historical valuations and increased demand for shares once the uncertainty of government ownership is removed.

So while RBS can't take the place of solid dividend paying bank stock, those with a long-term horizon could find a good value in this beaten down British bank.

One safer bank to balance your financial portfolio
When the financial crisis hit, investors in banks like RBS were nearly wiped out. To this day, many investors are terrified about investing in big banking stocks after the crash, but the sector has one notable stand-out. In a sea of mismanaged and dangerous peers, it rises above as "The Only Big Bank Built to Last." You can uncover the top pick that Warren Buffett loves in The Motley Fool's new report. It's free, so click here to access it now.

Alexander MacLennan is long Jan 2015 $20 calls on Bank of America and is long Bank of America Class B warrants. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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