I’m looking to generate a second income from investing in FTSE 100 shares and Barclays (LSE: BARC) looks tempting right now. Its shares are among the cheapest on the entire lead index, trading at just 5.1 times earnings with a price-to-book value of just 0.4.
That’s marginally cheaper than rival Lloyds Banking Group, which trades at 6.2 times earnings with a PB of 0.6, as the banking sector remains out of favour with investors.
Too cheap to ignore
The shadow of the great financial crisis still hangs over big banks, and the spectre of another banking crisis has chilled sentiment again. The Barclays share price is down 10.7% over the past three months, and flat over 12 months.
I’m tempted to buy it, given that low valuation, and the fact that it still makes oodles of money.
Last month, Barclays reported a 16% jump in pre-tax profits to £2.6bn, with growth across all its businesses. It’s reaping the rewards of rising interest rates, which is boosting net interest margins, the difference between what banks pay savers and charge borrowers.
That’s a key figure for bank profitability and climbed from 2.62% to 3.18% in a year. It should climb again after the Bank of England hiked the base rate to a 15-year high of 4.5% this month, and it’s expected to hit 5% this year. Barclay’s overall operating margins are forecast to rocket from 28.1% to 45.3%.
Barclays is now a top income stock, forecast to yield 5.6% this year, covered a hefty 3.7 times by earnings. If I was to invest this year’s full £20,000 Stocks and Shares ISA allowance, I’d get a second income of £1,120 a year.
However, the maximum I would invest in an individual stock, given the size of my portfolio, is just £5,000. That would give me income of £280 a year, which is hardly life-changing. However, it should grow steadily over time as Barclays has plenty of scope to increase its dividends, given current high cover and cash flows.
Rewards outweigh the risks
My worry is that banking stocks have proved a value trap over the years. A full decade ago, Barclays stock traded at just over 300p. Today’s price of 156p is roughly half that level. While investors will have received some dividends in that time, they will still be sitting on a major loss.
Another worry is that we can’t be sure the banking crisis is over yet. Barclays has more exposure than Lloyds Banking Group and NatWest, due to its investment banking operations. Another risk is that campaigners have renewed calls for a windfall tax on profits. The big banks are also being investigated by MPs for profiteering from low savings rates.
A US recession wouldn’t help, with Barclays recently increasing its bad debt provisions from £141m to £524m, as it anticipates an increase in US card delinquencies.
Yet I think many of these risks are reflected in today’s dirt cheap valuation and I hope to buy Barclays over the months ahead, with a minimum 10-year view to help me overcome any short-term volatility. I’ll reinvest my dividends for growth today, then draw them in retirement as a second income.
