FTSE 100 stocks in focus: how undervalued is Barclays?

Dr James Fox takes a close look at FTSE 100 giant Barclays and explores whether the stock is undervalued at its current share price.

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Barclays (LSE:BARC) is a FTSE 100 stalwart. The bank, which was the second largest in the world at the time of the financial crash, hasn’t been universally popular with investors for some time.

But what about now? Does Barclays deserve to be an unloved British bank?

Improving fortunes

Barclays has faced some challenges over the past year. To start, banks have needed to put more money aside for bad debts as the economy weakens and recession becomes more likely.

In Q3, impairment charges for the quarter rose to £381m, an increase on the £120m a year ago. On a nine-month basis, the charge for potential bad debts rose to £722m, versus a release of £622m in the previous year.

Barclays generates around 66% of its revenue in the UK, that less than some peers, but it’s clearly very exposed to the British economy. Around £7.5bn came from the US in the last financial year.

Barclays also agreed to a $361 million penalty over internal control failures related to the unregistered offer and sale of “an unprecedented amount” of securities.

However, things are improving. And higher interest rates are a major part of this. Some analysts predict that this could lead to an interest rate tailwind of £5bn in incremental revenue by 2025. 

This is because banks imperfectly pass on higher lending rates to customers, pushing net interest margins up. But also because Barclays is now earning more interest on its deposits with the Bank of England. Calculating exactly how much the bank will accrue is dependent on eligible assets held as central bank reserves. 

It banking peer, Lloyds, could earn as much as £200m for every 25 basis point hike.

Attractive valuation

There are two common methods to determine value. The first is to look at relative value, comparing near-term metrics with peers within the same sector. This is where financial metrics such as the price-to-earnings (P/E) ratio and price-to-sales ratio are useful.

Barclays trades with the lowest P/E ratio of all major UK at 4.65. That partially reflects the fines and money put aside for bad debt, but is considerably below peers like HSBC at 11.

The second valuation method is looking at intrinsic value through the discounted cash flow (DCF) model. This method attempts to estimate the underlying value of a company, based on the present value of its future cash flows.

One DCF calculation suggests that Barclays could be undervalued by 68%. That’s considerable, and rather illuminating. The problem with the DCF calculation is that forecasting future cash flow can be challenging.

However, the broad conclusion from the these calculations is that Barclays is undervalued, and by some margin. As such, I’m buying more of this stock to my portfolio.

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.

James Fox has positions in Barclays Plc and Lloyds Banking Group Plc. The Motley Fool UK has recommended Barclays Plc, HSBC Holdings, and Lloyds Banking Group Plc. 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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