3-Point Checklist: Should You Buy Lloyds Banking Group PLC Or Royal Bank Of Scotland Group plc?

Is it time to switch out of Lloyds Banking Group PLC (LON:LLOY) and into Royal Bank of Scotland Group plc (LON:RBS)?

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Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) has delivered the goods for shareholders over the last three years, climbing 152%, while its bailed-out peer Royal Bank of Scotland Group (LSE: RBS) (NYSE: RBS.US) has delivered a miserly 35% rise.

Lloyds’ outperformance has continued in 2015: so far this year, Lloyds’ shares are up 5%, while those of RBS have fallen by 12%.

After such a strong performance, I think it’s important to review the situation: markets are forward looking, and much of the good news we’ve seen from Lloyds was priced into the bank’s shares before it actually happened.

I think that there’s a possibility that RBS could start to deliver serious gains over the next year, as two key catalysts — a return to private ownership and the resumption of dividend payments — draw nearer.

In this article I’ll take a closer look at each stock.

68% upside?

Lloyds is currently valued at 1.2 times its net asset value, whereas RBS trades at just 0.7 times book value.

Re-rating RBS shares to the same price/book ratio as Lloyds would deliver a 68% gain for RBS shareholders, but I don’t think this is realistic.

RBS has a costly investment banking operation, and a history of big asset write-downs and disposals. The bank’s book value has fallen by 30% since 2009, whereas Lloyds’ is unchanged.

In my view, a further reduction in RBS’s book value is likely this year. I also think that RBS’s investment bank means that the RBS group may be valued at a discount to Lloyds’ simple, profitable high street banking business.

Earnings contrast

The differences don’t stop there.

Despite trading on a lower price/book ratio than Lloyds, RBS has a higher P/E valuation, and is expected to deliver lower adjusted earnings per share (eps) growth in 2015 and 2016:

 

Lloyds Banking Group

Royal Bank of Scotland

2015 forecast P/E

10.1

11.7

2015 forecast eps growth

+109%

+45%

2016 forecast eps growth

+6.3%

-3.2%

There’s little good news for RBS shareholders here, but what about dividends, the hope of which powered much of Lloyds’ share price recovery?

Dividend comparison

Here’s how the two companies compare in the dividend department — but keep in mind that unlike Lloyds, RBS hasn’t yet got permission to restart dividend payouts:

Dividend yield

Lloyds Banking Group

Royal Bank of Scotland

2014 actual

0.95%

0%

2015 forecast

3.5%

0.3%

2016 forecast

5.4%

2.6%

Today’s best buy?

At the start of this article, I suggested that it might be time to switch out of Lloyds and into RBS. However, having looked more closely at the figures, I’m not convinced.

In today’s market, I think I’d rather own shares in Lloyds than RBS.

However, banking shares are extremely difficult to value.

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.

Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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