Successful investors use a disciplined approach to picking stocks, and checklists can be a great way to make sure you’ve covered all the bases.
In this series I’m subjecting companies to scrutiny under five headings: prospects, performance, management, safety and valuation. How does Royal Bank of Scotland (LSE: RBS) (NYSE: RBS.US) measure up?
RBS is a universal bank but further shrinkage of its investment bank, flotation of US Citizen’s Bank and disposal of the remaining interest in Direct Line will make the business mix something in-between Barclays and Lloyds.
RBS has made good progress in shedding non-performing and non-core assets since its disastrous acquisition of ABN-Amro just before the financial crash led to a government bail-out and change of management.
However, it is less far down the path than Lloyds, and the larger state ownership (81%) and role of the bank in the corporate sector makes for greater government interference. A much-belated split of good bank/bad bank is again on the cards.
Since becoming CEO in November 2008 Stephen Hester has made great progress in RBS’s turnaround and the bank’s shares slipped the day he was unceremoniously ousted by the Chancellor.
The chairman has also indicated he will leave after a new CEO is identified, while the generously remunerated American finance director left to head up Citizen’s Bank last month, replaced by the chief risk officer. There could be a dangerous lack of corporate memory once the privatisation process eventually gets underway.
The Prudential Regulatory Authority identified a £14bn shortfall in RBS’s capital at year end 2012. However, RBS expects this to be reduced to £3bn by end 2013 and, on its reading of regulations, it believes the shortfall to be just £0.4bn.
With a large amount of ‘non-core’ assets still on its books, RBS is more vulnerable than the other UK banks to any shocks to the economy or banking system.
The greater risk in RBS’s balance sheet is reflected in a price: tangible book ratio of 0.6 (after taking into account the government’s ‘B’ shares), significantly lower than Lloyds’ 1.1. That still makes for a pricey 16 times prospective price-to-earnings ratio (though a decent 4.4% yield).
While the market believed Lloyds has turned the corner, marking its shares up 100% over the past 12 months, RBS has just kept pace with the FTSE 100.
Privatisation of RBS is some way off, so government interference remains a risk to add to RBS’s self-inflicted vulnerability. De-motivation and change of management adds another layer of risk.
Nevertheless, with the turnaround programme in full swing, and further major asset sales on track, patient investors should eventually see an uplift in the shares to a sensible price:book ratio, provided there are no accidents along the way.
RBS is a speculative investment, but one that can make sense alongside more dependable, safer bets on the market, such as the five companies in this report. They each have dominant market positions, healthy balance sheets and robust cash flows that underpin their reliability and future dividends.
You can download the report by clicking here — it’s free.
> Tony does not own any shares mentioned in this article.