Are you looking to invest in a bombed-out sector that could be on the verge of a major recovery? One where the valuations are dirt cheap but the dividend income prospects bright and shiny? Then look no further than the FTSE 100 banks.
They have had a terrible time for a decade. Universally loathed for their role in the banking crisis, reviled for the PPI mis-selling scandal and a constant source of disappointment to investors. Now on the verge of a major comeback.
Barclays (LSE: BARC) and Royal Bank of Scotland Group (LSE: RBS) have both published their 2018 results this month and although far from perfect, they do give grounds for hope.
Barclays posted headline profit before tax of £3.5bn, unchanged from the previous year. Once you strip out £2.2bn of litigation and conduct charges, hopefully one-offs, profits actually rose 20% to £5.7bn. Management also announced a final dividend of 4p, or 6.5p for the year, and alerted investors to the prospect of buybacks where appropriate.
It’s about time investors had something to celebrate given that the Barclays share price is down 20% over the past year and trades 37% lower than five years ago.
This has slashed its forward price/earnings ratio to just 7.09 times, the lowest among the big five FTSE 100 banks. The figure is comfortably below its five-year average P/E of 9.16 times, which suggests the stock is yours for a bargain price right now. As does a price-to-book ratio of just 0.4, well below the 1 usually seen as fair value.
Barclays now offers a generous forward dividend yield of 4.9%, with good cover of 2.8. By 2020, that income stream could hit 5.6%. I think Barclays is back.
RBS has been in the black for two successive years now, which is quite a feat given its problems. Earlier this month it posted an attributable profit of £1.62bn for 2018, more than double the £752m it generated in 2017. It paid its first dividend for a decade in 2018, but last week announced a 7.5p special dividend, on top of its final ordinary dividend of 3.5p.
RBS now offers a forward dividend yield of 5.1% with cover of 2.1. By 2020 it is forecast to yield 6.3%. It trades at a forecast 8.8 times earnings, with a P/B ratio of 0.7. It might just thrash the FTSE 100.
Winds of change
There are still headwinds for both banks. Brexit is a biggie (Barclays has set aside £150m to deal with any fallout from no deal). Low interest margins are another, with interest rates going nowhere at the moment. There could be a final rush of PPI claims before 29 August deadline, on top of the £33.5bn the banks have already paid out. Investors will also take time to overcome years of mistrust. However, these may blow over in the months ahead, making now a good time to get in before sentiment ratchets up another notch.
Perhaps the biggest underlying worry is the state of the UK and global economy, as loan impairments could rise if things turn nasty. I still think the future looks brighter for both banks.