LONDON -- Thomas Moore is an investment director at Standard Life Investments. I recently spoke with Moore to understand why he believes these three bank shares are a good bet.
The sector
All three have had a great 12 months. In the last year, shares in Barclays (BARC 0.86%) (BCS +0.79%) are up 46.2%. Lloyds Banking Group (LLOY 1.12%) (LYG +0.19%) is up 80.7%, and Royal Bank of Scotland (RBS 0.89%) is ahead 22.3%.
Yet, Moore believes further rises are ahead. "The banks have largely erased their capital deficits. They can no longer be accused of having a capital shortfall. In the case of Lloyds and RBS, there were large non-core assets that have had to be worked off. The stronger economic environment will help with this immensely. Reasons for these stocks to trade at a discount are disappearing quarter by quarter."
The politics
Considerable political heat has been turned on the banks since the credit crunch. This hasn't just been the media -- government ministers have also attacked them regularly. This has included calls for tighter controls on staff pay, more regulation and big changes in the way that the banks operate. None of this has been good for share prices. However, there are signs that such pressures are now easing. There is now little political capital to be made from bank-bashing.
"Regulatory pressures are easing," says Mr Moore. "There are clearly no serious capital problems among the listed banks. It is now in politicians' interest to see that the government stakes in Lloyds and Royal Bank of Scotland are returned to private ownership. Their interests are now aligned with shareholders' as the taxpayer needs to recoup its losses. To achieve this, there has to be an understanding that the banks must be allowed to get back to making profits."
Barclays
"Barclays is a company that the U.K. should be proud of," says Moore, "The company has great pedigree, built over more than one hundred years. Today, Barclays' core operations deliver returns well in excess of the bank's cost of capital. The LIBOR scandal and chief executive Bob Diamond's departure were a great a buying opportunity."
Barclays shares currently trade at 8.6 times broker forecasts for 2013. That's significantly below the price-to-earnings (P/E) ratio of 11.6 that HSBC enjoys. Barclays is forecast to increase its dividend 11.3% this year, followed by a huge 28.7% rise for 2014. The forecast earnings and dividend growth mean that the shares are available today on a 2014 P/E of just 7.2 times analyst estimates, with the prospect of a 3% dividend yield.
Lloyds
Lloyds has put in a better share price performance than Barclays and RBS 2013. In the last month alone, the shares are up 21.1%. A large amount of this rise was inspired by the bank's recent Q1 results. Lloyds reported a big fall in impairments, no further PPI compensation provision and a profit before tax of more than £2bn.
On Lloyds, Mr Moore says: "Of the three, Lloyds is running down its non-core book fastest. As the bank has demonstrated a return on equity greater than its cost of capital, the discount to book value has closed."
Royal Bank of Scotland
For my money, RBS has the greatest upside potential from here. The bank currently trades at a discount to net tangible asset value of more than 50%. If management can prove a turnaround, the possible gains are huge. If RBS can return to paying a dividend, this should then inspire further rises.
"RBS has become a much more focused bank" says Moore. "Any future dividend payment would force a rerating according to that yield. The shares would then be treated by the market just like any normal company."
Words of caution
Investing in these banks is not without risk. As Moore says, "they are among the most highly geared companies on the markets today. The future of the UK's banks is inextricably linked with the wider economy."
If Mr Moore and I are correct, then these three banks represent an opportunity that investors cannot afford to miss. If you are looking to make big returns on stock market investments, then check out the Motley Fool report "10 Steps to Making a Million in the Market." This analysis is totally free and will be delivered to your inbox immediately. Just click here to get your copy today.
