VALUE INVESTING
How To Find Cheap Banks

By Stephen Bland (TMFPyad)
June 3, 2005

Banks are by far the largest sector by capitalisation in the FTSE100 index. There are eight companies with a total market value of about £262bn. Oils are the second largest with three companies totalling about £181bn. Any diversified high yield portfolio (HYP) such as those I feature in my Value Investor newsletter is thus near certain to include at least one bank or maybe more depending on the number of shares in individual portfolios.

(Incidentally my first Value Investor HYP completed in April 2005 and built up monthly since January 2004 shows a gain so far of 13.2% including dividends. I'm happy with this given that the average holding time to date is only about eight months. I commenced the second Value Investor HYP in the May edition.)

It so happens that banks contain at present the highest yielder in the whole index, Lloyds TSB (LSE: LLOY), a share in which I have a couple of quid right now, but where do banks stand as short-term value plays generally, looking at the common value tests? My pyad filters test four aspects of fundamentals, the D of which is debt, something which is not considered much with banks because the borrowing and lending of money is actually their trade. That leaves us with the three others.

Forecast P/E first and ranking these by consensus forecasts takes us from the lowest which is Royal Bank of Scotland (LSE: RBS) on 8.3 to the highest, being Standard Chartered (LSE: STAN) on 14.1. The average for the sector is 10.2. Thus RBS is trading at a discount of 19% to the sector average P/E.

Forecast yield next and these range from Lloyds at 7.4% down to Standard on 3.4% with a sector average of 5.0%. Thus Lloyds is trading at a premium of 48% to the sector average.

Finally, historical tangible assets in the shape of P/TBV. These range from the lowest being HBOS (LSE: HBOS) on 2.11 to the highest, Standard yet again, on 3.68 with a sector average of 2.94. HBOS is therefore on a 28% discount to the sector average P/TBV.

These are the typical filters, plus debt in the case of most companies, I'd use for any initial search for value trading shares to feature in Value Investor whether in a sector or across the market.

Standard is the dearest bank on all three measures. More interestingly is to locate the cheapest of the banks. Not as obvious as Standard because each filter throws up a different cheapest share, RBS, Lloyds and HBOS on P/E, yield and P/TBV respectively.

Looking deeper into this reveals that RBS whilst having the lowest P/E has the second highest P/TBV and is a below average yielder. It therefore has only one clear value feature.

In contrast HBOS, whilst possessing the lowest P/TBV, is also the second lowest P/E at 8.7, well under the sector average. Its yield though at 4.6% is marginally below the average so it has two value features.

Finally, Lloyds. Whilst it's the yield leader by a long way at 7.4%, more than one percentage point over the second, Alliance & Leicester, it's P/E of 10.0 is around average and it is amongst the highest P/TBVs. Thus Lloyds scores on only one value feature.

My conclusion is that analysing FTSE100 banks shows HBOS to be the cheapest on the basis of being top of at least one list and having the most of the other two lists. Note though that different investors might weight differently the importance of the three lists. As always with value, the mechanical filters are just start points to prepare a short list for a little further investigation – but not too much, you don't want to overanalyse.

If I was looking for a large cap from the largest cap sector of all, banks, to feature as a Value Investor short-term play, this is how I would start going about it.

Get three free share tips when you sign up to a trial of Value Investor.

Stephen owns shares in Alliance & Leicester and Lloyds TSB.