Is the RBS share price a bargain or should I buy this dividend-growing mid-cap?

This dividend-paying mid-cap is outperforming cheap-rated Royal Bank of Scotland plc (LON: RBS).

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A stock that always appears on my value screens is FTSE 100 bank Royal Bank of Scotland (LSE: RBS). For the past 10 years, shares in the firm have traded below book value as investors have watched the bank try to rebuild itself from the sidelines.

It reached a significant landmark in its recovery last week when, for the first time since the financial crisis, RBS paid a dividend.

Time to buy?

RBS’s return to the dividend club should not be underestimated, in my view.

The fact that management is now confident enough to start distributing retained profits shows that they believe the bank has rebuilt its capital reserves to acceptable levels. What’s more, the reintroduction of the payout indicates that management is optimistic about the future for the enterprise.

Earnings per share (EPS) are forecast to increase by 35% for 2018, followed by growth of just over 5% for 2019. In the years after, there are plenty of tailwinds that could help the bank continue its growth streak. For example, the PPI deadline, and rising interest rates, should lead to more profitable trading conditions in the near term. 

Given this growth outlook, shares in RBS appear to offer good value, trading at a forward P/E of just 9.

And what about the dividend? Well, after its token 2p per share interim payout, analysts are expecting a second final dividend of around 4.5p for 2018, giving a full-year payout of 6.5p. Next year, a full-year distribution of 9.2p is predicted as management ramps up efforts to reward long-suffering shareholders. Based on these predictions, a potential dividend yield of 4.1% is on offer for 2019.

Slow and steady 

RBS looks to offer good value at current levels, but many investors remain cautious about the group’s outlook, due in part to its troubled history. If this puts you off, in my opinion, Arbuthnot Banking (LSE: ARBB) has similar attractive investment qualities.

Shares in Arbuthnot trade at a premium compared to RBS because the company has a stronger record of profitability. Unlike RBS, it’s been consistently profitable for the past six years, and analysts are predicting EPS growth of 33% in 2018, followed by an increase of 55% for 2019.

While these figures do suggest a pricey forward P/E of 23, the stock’s PEG ratio of 0.4 indicates to me that the shares are undervalued, based on Arbuthnot’s growth potential. In a trading update published today, the company confirmed that it’s on track to meet the City’s growth targets for the year.

On top of its growth potential, Arbuthnot has also earned a reputation as a dividend growth stock over the past six years. The payout has grown at a steady 6% per annum since 2012, and with EPS set to leap 33% in 2018, I’m confident this trend will continue. 

With this being the case, now could be the perfect time for dividend growth investors to buy Arbuthnot.

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.

Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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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