There’s no doubt it’s been a torrid few years for Barclays’ (LSE: BARC) shareholders. The bank’s share price is down almost 17% year-to-date and has halved in the last three years.
First-quarter results in March were disappointing, with a 25% drop in pre-tax profits on the back of huge PPI claims, fines in relation to forex rigging and underperformance from the investment banking division.
To make matters worse, Barclays announced that it would be slashing its dividend to just 3p per share for the next two years, in order to conserve capital and absorb losses from toxic assets. That takes the forecast yield to a low 1.64% for next year’s dividend payout.
All in all, it’s not a pretty picture at Barclays, and while there’s a chance that the new CEO may be able to turn things around down the track, there certainly doesn’t seem to be much short-term momentum at the bank.
Not that you’d know from their share prices, which have both also struggled in the last 12 months.
But to my mind, there’s a clear disconnect between the performance of these banks and their share prices.
Because whereas Barclays is clearly struggling to increase its earnings, both of these challenger banks are enjoying strong earnings growth.
For example, Aldermore reported adjusted earnings per share of 24p for FY2015, up from 18p in FY2014, a rise of 33%. And with city analysts pencilling-in earnings of 26p and 30p for the next two years, this bank definitely appears to be heading in the right direction.
Similarly, OneSavings Bank reported FY2015 earnings of 35p per share, up from 25p in FY2014, a year-on-year increase of 40%. Analysts have earnings per share estimates of 40p and 43p for the next two years.
Yet despite this stellar growth, both of these challenger banks appear to be trading cheaply.
Aldermore trades on a current P/E ratio of 9.5, which drops to just 8.3 on next year’s earnings. And OneSavings Bank’s current P/E ratio is 9.7, dropping to 8.4 on next year’s earnings.
Given that Barclays trades on a P/E ratio of 13.3 times next year’s earnings, the challenger banks certainly appear to offer relative value.
Income investors will be interested to know that while Aldermore doesn’t yet pay a dividend, OneSavings Bank paid out 9p per share in dividends last year, a yield of 2.7% at the current share price. Analysts have forecast dividends of 10p and 12p for the next two years, so there’s potential for dividend growth here.
Of course, the challenger banks aren’t without their own risks.
Both Aldermore and OneSavings Bank specialise in mortgage lending, and with the UK government cracking down on ‘buy-to-let’ mortgages, there’s an element of uncertainty here. Brexit fears are also almost certainly contributing to the recent share price weakness of the challengers.
And given that they’re smaller companies, it’s likely that their shares will be more volatile.
But in my opinion, the challenger banks offer a great risk-to-reward ratio right now. My advice would be to diversify between a handful of challenger banks, in order to reduce company-specific risk.