Based on a multitude of factors, I don’t see how Barclays (LSE: BARC) could ever surge to 540p a share from its current level of 270p… but if we talk about probabilities, then it’s more likely that Lloyds (LSE: LLOY) will plunge to 40p a share from its current value of 80p, in my opinion!
I think there are opportunities to make a fast buck in the banking sector if you closely monitor daily trends, but here at the Fool we are chasing long-term value, and that’s a precious commodity nowadays.
Trust & Performance
Trust, or the lack thereof, is a big issue in the banking industry.
And that’s one problem.
Another major headache is posed by bullish estimates for growth, which come from a rather low earnings base in 2014, but could leave the shareholders of both banks with a bitter taste in their month.
I hear you: Barclays and Lloyds could be a nice yield play!
But then again, other less cyclical sectors — such as the tobacco industry, for instance — offer more promising all-in returns over the next five to 10 years, I’d argue.
Earnings/Litigation Risk/Others
Litigation risk is the biggest threat to value, I believe, and is not properly priced into the shares of Barclays and Lloyds.
However, their quarterly results recently showed that both banks are doing better than in the past based on fundamentals, impairments, net interest income margin and costs.
Capital ratios are in good order, too.
We are faced with two scenarios here, however — neither of which is very enticing.
Interest Rates
On the one hand, if interest rates rise, the underlying quality of their assets will be severely tested, and the benefits (rising core margins) will unlikely offset possibly higher impairments and costs.
On the other, if interest rates stay around their current levels or fall further, shrinking profitability will go hand-in-hand with dramatic cost cuts, which could harm competitiveness.
Lloyds is better positioned than Barclays based on its cost-to-income ratio, but a lower cost base also means that the stock of the former could offer less upside if the macroeconomic landscape did not change much in spite of accommodative monetary policies.
Remember: any rise in interest rates will be gradual, if it occurs.
Management Risk
Moreover, Barclays still has to decide what kind of financial institution it wants to become when it grows up: will it ever abandon its investment banking ambitions, for instance?
That’s hard to say because the bank only recently fired its chief executive, and what’s next remains a big question mark. The same applies to the management team of Lloyds. Private ownership is just around the corner, but what will happen after the government has recouped the taxpayers’ money is unclear.
I’d say that Lloyds investors will likely ask for higher returns and a more aggressive strategy with regard to capital returns, neither of which is very likely until certain risks persist.
So, if you are keen to invest in either stock, ask yourself: why should I bother about shares boasting lowly, unadjusted trading multiples that do not factor in one-off events, such as additional PPI provisions?
Payment Protection Insurance charges and similar items will affect the capital allocation strategies of both banks for quite a while. Right now, neither stock is incredibly expensive based on their price-to-tangible book value ratios and several other trading multiples, but that’s never a good reason to invest in equities.
