VALUE INVESTING
Any Value in Banks?

By Stephen Bland (TMFPyad)
March 10, 2006

My usual approach to locating value shares for trading has been bottom up. By this I mean that instead of considering sectors or anything to do with the individual business of the shares, I filter the whole market on value ratios like P/E, yield, P/TBV and debt. Any shares thrown up are then considered in a little greater detail to ascertain their suitability as value plays. At that stage though I pay little heed to the nature of the businesses because it has been a search for value, regardless of what the company actually does for a living.

An alternative approach to finding value shares can be the top down style. It's not my preferred approach though I have used it. Here you start off by considering a sector which has a low valuation placed upon it compared with market averages and then examine its individual constituents for likely value candidates. The market has fashion streaks so that at any time there will always be sectors that are cheap and those that are dear relative to the averages. These sector fads change over time though the period during one may be in or out of vogue can be quite lengthy. As always with value you need great patience.

At present the P/E on the All Share index is about 14.1 and the yield 2.9%. One sector, and it's one of the biggest of all sectors, that is cheap by comparison is banks. There are nine in the sector and here are their ratios ranked by forecast P/E with forecast yield and last actual P/TBV shown also. Debt doesn't matter with banks by the way. Note that these are database extractions and therefore the chance of error always exists. I haven't checked back to the accounts of the companies.

Company	Price	P/E	Yield	P/TBV
Royal Bank of Scot. (LSE: RBOS)	1,910p	10.0	4.32	4.23
HBOS (LSE: HBOS)	994p	10.3	4.00	2.58
Barclays (LSE: BARC)	652p	10.7	4.57	3.27
HSBC (LSE: HSBA)	990p	11.4	4.49	3.88
Lloyds TSB (LSE: LLOY)	543p	11.8	6.30	4.15
Bradford & Bingley (LSE: BB.)	471p	12.7	4.20	2.47
Northern Rock (LSE: NRK)	1,120p	12.9	3.06	3.25
Alliance & Leicester (LSE: AL.)	1,070p	13.0	5.08	2.80
Standard Chartered (LSE: STAN)	1,450p	15.3	2.83	5.27
Average		12.0	4.32	3.54

The bank sector incorporates the five big clearers, which by chance happen to form the first five shares in the P/E ranking, the three former building societies which constitute the next three with specialist international bank Standard Chartered, being perhaps something of a special case, at the bottom.

So what does this table tell us?

Well, the whole sector can be represented by a single mythical bank with a P/E of 12.0, a yield of 4.32% and a P/TBV of 3.54. I don't have a P/TBV for the whole market but these P/E and yield figures are cheaper than the market averages I mention above but not to the same extent. In fact the yield of 4.32% is better than 2.90% to a much greater degree than the P/E at 12.0 cheaper than 14.1.

Okay, our single sector bank is cheaper than the market on P/E and yield. Therefore at this stage the whole sector could be considered a buy for a value player. Few though would buy the lot, though that actually might be a feasible value strategy. Most value investors will search through the constituents for a likely single play.

As can be seen Royal Bank is the cheapest on P/E, Lloyds on yield and Bradford & Bingley on P/TBV. Damn, be nice if the cheapest stuck out more by featuring in at least two or ideally all three filters. So which one to go for? This depends on the weight you attach to the individual ratios which is very much a personal thing.

In my view the market will attach the greatest importance to P/E, thus making Royal Bank a winner, but only slightly, over the next few shares in the table. Royal Bank has also an average sector yield. P/E is by far the most popular ratio amongst analysts and commentators for comparing shares. Whatever you think of the qualities of this ratio, and it is easy to criticise, there is something to be said for playing the same game as the rest of the market even if you don't quite agree with its rules.

Other value players may home in on yield as the primary attraction. Lloyds wins here by a long way. Interestingly, Lloyds, mirroring Royal Bank, has about an average P/E. It was principally Lloyds' very high yield, not just by the standards of the bank sector but against the whole FTSE100, which has led me to hold the majority of my money in this share in which I increased my holding when the price fell. For years it has been one of the highest yields in the index and has tested my patience to put it mildly. The yield has yet to out. I've maintained that the position of being such a relatively big yielder cannot continue indefinitely but so far it has. I remain convinced that sooner or later this yield will fall dramatically, and not by a cut in the dividend either. Meanwhile in true value style it is paying me a handsome income whilst I'm waiting.

The P/TBV leader but not by a big margin is Bradford. However all of these shares trade way above book. In fact banks are very rarely going to be asset plays, though I have seen it happen in extreme bear markets. I doubt though that P/TBV is a particularly important ratio as far as bank shares are concerned for value players. Interesting to see perhaps but I personally would probably not attach much weight to it in present market conditions.

Of the shares mentioned Stephen holds Alliance & Leicester and Lloyds.