2 bargain bank stocks that could help you retire with a million

The UK’s banking stocks still look like they could be seriously undervalued.

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Can the banks do nothing right? According to the BBC, which has seen a leaked FCA report, the department set up by Royal Bank of Scotland Group (LSE: RBS) to help companies in trouble was found to have hit more than 90% of viable business with some inappropriate action, like raised interest charges.

Whether there’s any further action against RBS as a result remains to be seen. But after years in the wilderness, the bank does finally look to me to be worth investing in again.

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So far I’ve kept well away from RBS as it has lagged some way behind my preferred Lloyds Banking Group in the recovery stakes. In fact, over the past five years, RBS shares have lost 1% in value, way behind the 54% rise in Lloyds’ shares and with the dividend still not restored — payouts at Lloyds resumed in 2014 and reached 4.1% last year.

Dividend coming back

But we should have at least a tiny dividend from RBS this year, followed by a yield of 3.2% next year, if analysts are to be believed. And with those mooted payments very well covered by forecast earnings, if RBS were to get anywhere near Lloyds’ payout ratio, I could easily see rises to 6% or more in the next few years.

Despite 2016’s full-year loss, RBS reported a first-half adjusted operating profit of £3bn this year, with adjusted earnings per share (EPS) of 16.3p, which suggests it’s finally heading in the right direction. 

Liquidity looks fine too, with a CET 1 ratio of 14.8% coming in comfortably ahead of the bank’s target of 13%.

With a forward P/E of 11.4, dropping to 10.5 for 2018, RBS shares look worth buying to me.

Upstart challenger

I also like the look of some of our so-called challenger banks, with Virgin Money Holdings (LSE: VM) probably my favourite.

Its shares soared when the bank was launched, reaching a peak of over 450p in mid 2015. But the economic events since, including the Brexit vote and weakening growth forecasts, have taken their toll — and as I write, the price is down to 302p.

But for me, that turns a bank that was already looking like a good long-term buy into a screaming bargain. Last year saw a 28% rise in EPS and a dividend yield of 1.7% — not cash cow territory just yet, but nearly six times covered by earnings and pretty good at this stage.

Forecasts suggest 24% and 6% EPS rises this year and next, dropping the P/E as low as 7.4 on 2018 forecasts (after 7.8 for the end of this year).

Steady progress

A third-quarter update on Tuesday affirmed the company’s full-year guidance, reporting gross mortgage lending of £6.5bn, net mortgage lending of £3.2bn (for a very impressive 10% market share), and credit card balances of £2.9bn. 

There are three key things I like about Virgin Money, in addition to the low valuation of the shares. Firstly, there are no legacy problems of the kind faced by the big banks, because Virgin simply wasn’t around to share in their misdeeds.

Then there’s the focus on UK retail business rather than higher-risk investment banking and international operations, which should provide a safety barrier. Finally, Virgin is still a small fish in a big pond, and it should find it easier than the big banks to grow its market share.

Growth, plus long-term dividend potential — that’s what I see.

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Alan Oscroft owns shares in Lloyds Banking Group. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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