Why I Sold Lloyds Banking Group PLC And Bought More Barclays PLC And Royal Bank Of Scotland Group Plc

This investor believes that Barclays PLC (LON:BARC) and Royal Bank of Scotland Group plc (LON:RBS) offer better risk:reward than Lloyds Banking Group PLC (LON:LLOY).

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The market increase from the beginning of the year pushed share prices to new highs. The following correction then presented opportunities to pick up shares at prices not seen in months.

In recent years, bank shares have typically exaggerated big market moves. However, the correlation between Lloyds (LSE: LLOY) (NYSE: LYG.US), RBS (LSE: RBS) (NYSE: RBS.US) and Barclays (LSE: BARC) broke down in the shakeout that began in May.

The FTSE 100 peaked on May 22. Since then, shares in Royal Bank of Scotland are down 19%. Barclays is down 14%. However, Lloyds is 2% ahead. I have taken the opportunity to reconfigure my bank exposure by selling Lloyds and buying more RBS and Barclays.

Why sell Lloyds?

Lloyds shares have been very good to me. The stock has been a great way of capitalising on the world’s recovery from the financial crisis. As the government looks like it will soon begin to sell its stake in the bank, Lloyds is not only out of intensive care, it is nearly back to business as usual.

Lloyds is again reporting profits. Impairments on bad loans and assets have been coming down — fast. There is the real possibility that the bank will soon restart dividend payments.

My problem with the shares is that all of this sunshine is now baked into the share price. Don’t get me wrong. Even with the shares today trading at a two-year high, Lloyds remains cheap.

According to the consensus of broker forecasts, Lloyds is trading on a 2013 price-to-earnings (P/E) ratio of 13.7. Expected growth next year pushes that P/E down to 10.7. That’s cheaper than many FTSE 100 companies, but a considerable premium to Barclays and RBS.

The case for Barclays

In its most recent trading statement, Barclays reported pre-tax profits for the quarter of €1.8bn. This would have been €500m higher but for restructuring expenses. Adding back these costs and multiplying by four gives a rough indication of just how profitable Barclays could be annually. Given that Barclays’ market capitalisation is today €35bn, the shares are incredibly cheap.

According to the consensus of broker forecasts, earnings per share (EPS) at Barclays will come in at 36.6p for the full year. As expenses are eliminated in 2014, an EPS increase of 20% is forecast, moving the final result up to 43.7p. Against today’s share price of 285p, that’s a 2013 P/E of 7.6, falling to 6.4 next year. Normally, the market reserves such miserable ratings for companies whose long-term future is at risk. Yet Barclays is strong, profitable and growing.

The only fly in the ointment is the dividend yield, at just 2.6% forecast. I hope that a more ambitious increase will be announced with interims at the end of this month.

Royal Bank of Scotland

So far this year, the lowest price that RBS shares have traded at is 266p. The highest is 367p. At 282p today, the shares are 5.7% from their low for the year and 30.1% off their peak. Taking these points as the likely share price bounds, there is a big profit in store if sentiment toward RBS can be turned for the better.

The fundamentals also suggest that RBS shares should be significantly higher. While the shares are today priced on a 2013 P/E of 12.5 times forecast earnings, massive profit growth is forecast for 2014. Analyst research suggests that RBS will report 31.9p of earnings per share in 2014. That puts the shares on a 2014 P/E of just 8.6.

Using an average of forecasts for the next two years, only eleven FTSE 100 companies are trading on a lower P/E. Of these, only one share is forecast to deliver more future growth than RBS. While it is a disappointment that there is no dividend, recent management comment has suggested that a payout could be declared at around this time next year.

The bank last reported net tangible assets of 459p per share. It is unusual for a profitable company to trade at such a significant discount to this figure. Even better, RBS has been reporting increases in its asset value.

If the asset valuation and earnings forecasts are reliable, then RBS shares are excruciatingly cheap today.

Buying shares ahead of a recovery in trading and sentiment can deliver big returns. For more wealth-building techniques that use the power of the stock market, get the our free report “10 Steps To Making A Million In The Market”. This report could change the way you invest, forever. Just click here to get your totally free copy today.

> David owns shares in Royal Bank of Scotland and Barclays but none of the other companies mentioned.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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