This growing business looks like a bargain

Is this sprightly company being undervalued by the market?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

I wouldn’t buy shares in the big-name UK-facing banks now, such as Lloyds Banking Group (LSE: LLOY), because growth is off the agenda. Lloyds expects earnings to come in flat during 2018.

But one firm shines like a beacon of light across the heaving quagmire that is the banking sector on the London stock exchange, and that company is Virgin Money Holdings (LSE: VM).

Sound progress

In a trading statement released today, Virgin Money revealed sound progress in its British retail banking business. Mortgage balances are up 3% compared to three months ago, credit card balances elevated 8% and deposit balances lifted 3%. The firm continues to win over customers and is building market share.

Chief executive Jayne-Anne Gadhia puts the ongoing operational momentum down to the firm’s customer-focused strategy of growth, quality and returns,” asserting that the company’s good results demonstrate the benefits of a low-risk business model, strong balance sheet and a focus on operational excellence.

Something is going right for sure because City analysts following the firm expect earnings to shoot up 17% this year and 13% during 2018, which trounces the likes of Lloyds. Both firms compete for the same customers and offer similar services. It looks like Virgin Money is winning.

Outlook and valuation

There’s no doubt that the UK banking market is competitive, but Virgin Money is confident that it can deliver against expectations for 2017 and today reaffirms its guidance for the full year.

With double-digit percentage earnings growth expectations on the table, we might expect a double-digit valuation. However, at today’s share price around 325p, Virgin Money trades with a forward price-to-earnings (P/E) ratio of just over eight for 2018, and the forward dividend yield runs at almost 2.4%.

Those anticipated forward earnings should cover the dividend payout around five times, which looks healthy. With high cover from earnings like that the directors must see plenty of opportunity for further growth, otherwise they would likely put more of the firm’s incoming cash flow into the dividend rather than investing more money in the business.

Out of kilter?

Meanwhile, at today’s share price of 67p, Lloyds Banking Group’s forward P/E ratio runs at 9.6 for 2018 and the forward dividend yield at around 6.2%. Anticipated earnings should cover the dividend payout just under 1.7 times. With so much cash inflow going into the dividend, my assumption is that the directors see little opportunity to invest for growth.

Lloyds’ price-to-book ratio sits around 0.98 and Virgin Money’s at 0.86 or so. Despite all the earnings growth that Virgin Money expects, the firm’s valuation is lower than Lloyds in terms of the forward P/E ratio and when comparing share prices to asset values.

All banking businesses are cyclical and can suffer from valuation-compression as the wider economic cycle unfolds and after a long period of strong earnings. Yet Virgin Money is growing and gaining market share, and I don’t think it deserves to be priced lower than Lloyds, which has a chequered history and an arguably less entrepreneurial culture.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

Could the JD Sports Fashion share price double in the next five years?

The JD Sports Fashion share price has nearly halved in the past five years. Our writer thinks a proven business…

Read more »

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

If interest rate cuts are coming, I think these UK growth stocks could soar!

Falling interest could be great news for UK growth stocks, especially those that have been under the cosh recently. Paul…

Read more »

Investing Articles

Are these the best stocks to buy on the FTSE right now?

With the UK stock market on the way to hitting new highs, this Fool is considering which are the best…

Read more »

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »