VALUE INVESTING
Banks Still Ooze Value

By Stephen Bland (TMFPyad)
March 7, 2003

Last October I did a feature on value amongst banks. Since the bank results season is now over, it is instructive to see how they have progressed from a value investor's viewpoint. The key ratios in my experience with banks happen to be the two most popular fundamental indicators used to measure shares across the market, P/E and Yield.

I like banks in a very depressed market like this because they are emotionally geared to it. When a recovery exerts itself, banks tend to recover at a much faster rate than the market as a whole, though there can be no guarantee of this of course. However, as with value generally, the investor needs great patience and must be prepared for further falls after buying. You can't call the bottom.

Since October the market has not moved by much overall, though in the meantime it did attempt a recovery which was soon aborted.

Here are the eleven listed banks in descending order of market value. Yields and P/Es are based on consensus analysts' forecasts.

                           Mkt Val £b      Price     Yield%      P/E
HSBC (LSE:HSBA)                  63.5       670       5.6       12.7
Royal Bank of Scotland (LSE:RBS) 39.8      1370       3.7        8.7
HBOS (LSE:HBOS)                  24.6       651       4.8        9.8
Barclays (LSE:BARC)              22.5       345       5.9        9.1
Lloyds TSB (LSE:LLOY)            18.6       334      10.3        7.4
Standard Chartered( LSE:STAN)     8.0       689       4.7       13.0
Abbey National (LSE:ANL)          5.5       378       6.6       10.0
Alliance & Leicester (LSE:AL.)    3.7       763       5.8       10.4
Northern Rock (LSE:NRK)           2.7       646       3.6       10.0
Bradford & Bingley (LSE:BB.)      1.9       286       5.9        9.2
Egg (LSE:EGG)                     0.8        96       0.0       57.1

From a value perspective, it can be seen that Lloyds sticks out both on yield and P/E grounds. The yield in particular is interesting because it did not cut its final dividend when it announced its the recent annual results (although many of the financial chattering classes had expected it to do so). Instead it maintained it, linking future dividends to dividend cover.

Lloyds has fallen a lot since my last bank article due to well publicised reasons, mainly its involvement with life insurance. Other banks have their fingers in this pie, but to a lesser extent. Life insurance shares are themselves a geared play on the market, so you could argue that Lloyds is doubly geared by being both a bank and a sizeable player in the life insurance business. Expect it therefore to put on some serious gains in any eventual market recovery. But that does not mean it can't go much lower still. It can, particularly if the market falls further and the gearing effect works in reverse.

Readers who are not aware may be interested to know that Lloyds traded in the bull market on a P/E of 20 and more. This was an absurdly high rating for a bank in my opinion and price at which it was overvalued. On the current forecast eps, this implies a rough trebling of the current share price were it to reach this level again (more if profits improve). I have no doubt at all that it will reach this level in a future bull market, such is the dependability of human nature. I just don't know when, hence the need for great patience. The waiting is ably assisted though by the massive yield, almost on a level of some dodgy share about to go bust and quite out of line for a major bank. The dividend may be cut in future of course and this is what the yield is implying. But even if it is, it is unlikely that the consequent yield on today's price will be that low and thus holding the shares would probably still give a return in excess of cash whilst you wait.

Abbey National is the other major sufferer from the bank shakeout, due to problems with the old story of going outside its field of competence. In Abbey's case it went into the clearing banks territory of business lending and related operations. It is now in the process of ridding itself of the dross and going back to its basic business of retail banking.

Note that unlike Abbey, the mortgage banks which stuck to their knitting, namely Alliance, Northern and Bradford all reported quite decent results with increasing dividends. However, they are not without a very specific risk factor. The mortgage and housing market has been buoyant in recent years, you could say booming. Should this crack too severely then expect some pain amongst this particular sub-sector of the banking industry. All the main banks do personal mortgages but that is not their primary business, unlike the four former building society shares.

I can't see that buying banks now will do anyone anything but good in the slightly long run when a recovery gets underway. But that does not mean they are attractive as very short term investments, unless by luck you hit it right on the recovery point. Lloyds though in particular continues to be the star play of the sector for the patient in my opinion. You will very rarely catch one of the major banks on a yield and P/E at these levels.

The author holds shares in Lloyds TSB.