Right now, I think shares in the Royal Bank of Scotland Group (LSE: RBS) look deeply undervalued.
I’ll admit in the past I’ve been sceptical about the company’s ability to recover from its self-inflicted problems in the years after the financial crisis. But it now looks as if the bankers at the group’s head have finally put this business back on a stable footing.
After agreeing on a substantial legal settlement with the US last year, the last major settlement related to misselling mortgage securities before the 2008 crisis, RBS has cleared the last of its big legal headaches to finally re-start dividends to investors.
Meanwhile, after years of restructuring costs and winding down the bad (loss-making) parts of the business, RBS’s profits have finally returned to growth. Indeed, analysts are expecting the firm to report a significant improvement on 2017’s operating profit of £2.2bn, and attributable profit of £752m. Net profit is projected to hit £3.4bn when the bank reports its numbers for 2018 later this week. Earnings per share should jump 41% to 28p off the back of this growth, analysts believe.
But despite this improvement, the RBS share price is still trading roughly where it was back in 2016, which I think presents a fantastic opportunity for investors.
Time to buy?
The share price has barely budged because it seems investors are worried about the impact Brexit might have on the bank. RBS is not alone. Virtually all UK banking stocks have slumped over the past 12-24 months as investors have shunned the sector.
Lloyds is a fantastic example. Shares in the business are trading at 2016 levels even though the bank’s profit has doubled during the past two years. This leads me to believe that when Brexit uncertainty is lifted, the RBS share price could fly higher.
Undervalued
So, how undervalued is the RBS share price? Generally speaking, profitable companies should trade at or around book value. Because RBS only reported its first annual profit since the crisis last year, a price-to-book value of less than one has been suitable for the stock for much of the past decade. However, now the company is profitable, I reckon it has the potential to trade up to book value of around 400p per share, based on last year’s numbers.
It might take some time for the share price to reach this level, but I believe both the unveiling of the firm’s second annual profit in a row later this week, as well as more clarity on Brexit, will act as the catalysts that start the rally.
Investors will be paid to wait for the move higher as, currently, the stock yield’s 2.9% and analysts expect it to hit 4.4% in 2019. Including this income, as the cloud of Brexit moves on, I reckon the RBS share price could yield a return of as much as 70% over the next few years.
