Stephen Bland picks his favourite banking share.
From time to time in my column I like to take a look at certain sectors of the market, in particular amongst big caps, to see if there's any value lurking there. Whilst I'm normally a bottom up searcher, I find that this sort of top down approach is especially useful where a whole sector is out of fashion, demonstrated by the sector average presenting value level ratings relative to the market.
There will usually be some ostensible reason why a sector is considered relatively undesirable by the market. The value investor needs to decide whether those reasons are valid or just the normal drift of noise or sentiment having little basis in reality. Banks as a sector have been viewed unfavourably by the market for quite a while.
Here's some data on the nine listed banks ranked by ascending P/E:
| Company | Share
Price £ | P/E | Yield
% | EPS
Growth % |
|---|
| Royal Bank Of Scotland
(LSE: RBS)
| 18.85 | 10.0 | 4.3 | 7.5 |
| Barclays
(LSE: BARC)
| 7.09 | 10.9 | 4.2 | 19.9 |
| HBOS
(LSE: HBOS)
| 10.82 | 11.3 | 3.7 | 11.2 |
| HSBC
(LSE: HSBA)
| 9.88 | 12.2 | 4.3 | 12.8 |
| Lloyds TSB
(LSE: LLOY)
| 5.66 | 12.3 | 6.1 | 3.5 |
| Bradford & Bingley
(LSE: BB.)
| 4.58 | 12.5 | 4.2 | 21.5 |
| Alliance & Leicester
(LSE: AL.)
| 11.30 | 13.4 | 4.8 | (2.9) |
| Northern Rock
(LSE: NRK)
| 12.09 | 14.0 | 2.8 | 19.1 |
| Standard Chartered
(LSE: STAN)
| 15.07 | 16.6 | 2.5 | 12.2 |
| Average | | 12.6 | 4.1 | 11.6 |
P/E and Yield figures are consensus forecasts and the EPS Growth column is the change in next year's forecast P/E over the last actual.
I chose P/E as the ranking criterion because it is probably the single most popular valuation ratio amongst all the various methods of measuring the relative valuations of shares despite many flaws. If you want to measure relative value in order to discover potential undervalue, you have to use the same measuring tools as everyone else whatever your opinion of their quality.
Yield is perhaps the most straightforward of all the ratios because there's no complex accounting arguments about how it is calculated. You can't argue with cash.
I show eps growth because value shares need an outer and in most of those cases it is eps growth.
I need to consider the purported reasons why the banking sector stands on a modest rating and whether those reasons carry much validity.
I can think of two main reasons that commentators are likely to offer. Rising interest rates and a possible property collapse. The latter would in particular hit the three former building society shares in my table: Alliance & Leicester, Bradford & Bingley and Northern Rock. Mortgage lending is the primary business for all three. If property really hit the rocks creating widespread bad debts, these shares would be creamed and it probably wouldn't do most of the others too much good either.
Therefore anybody fearing such an event should really avoid banks in my view. Personally I don't think it is imminent though it can happen, I've seen it all before.
For those prepared to discount the fears surrounding the low bank sector valuation, which shares appear the most attractive? That depends on the particular importance you attach to each individual value filter. In my table Royal Bank is the lowest P/E, Lloyds the highest yield and Bradford & Bingley strongest growth. There is no clear winner across the board unfortunately.
The top three eps growers are close, nothing much to choose between Bradford's 21.5%, Barclays' 19.9% and Northern's 19.1% given that we're talking forecasts here with all the imprecision that goes with them. These three though are markedly ahead of the others on this feature. For PEG fanciers, dividing the P/E by the growth shows Barclays top on 0.55, followed closely by Bradford on 0.58 with Northern behind on 0.73 and the rest nowhere.
On yield Lloyds is in a league of its own with a substantial gap between its 6.1% and second placed Alliance on 4.8%. The problem with the Lloyds yield is that its dividend has remained static for years, which may explain its yield premium over the other banks though some analysts are forecasting a very small increase.
So which one is the best short term value play right now for those who fancy a bank? It has to be Barclays in my opinion because it has the strongest eps growth outer combined with the second lowest P/E. Add to that its yield of 4.2%, which is marginally above the sector average and that clinches it I'd say. Also, the major banks are probably a little less risky than the mortgage banks given the latter group's greater exposure to property.
Of the above shares, Stephen holds Alliance & Leicester, Lloyds TSB, and Royal Bank of Scotland.
