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Will Barclays Plc, Lloyds Banking Group PLC And Royal Bank of Scotland Group Plc Continue To Thrash The FTSE 100?

Wiser investors than I refuse to go anywhere near the big banks. Many of my fellow Fools shun Barclays (LSE: BARC) (NYSE: BCS.US), Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) and Royal Bank of Scotland (LSE: RBS), deterred by a toxic cocktail of inscrutable balance sheets and poisonous political risk. The banks aren’t aren’t just too big to fail, they are also too big to value accurately. For a purist, they are the investments from hell.

But I’m no purist. I’m more concerned with whether I can make money out of them. And any investor who bought into the banks in the last few years has certainly made a tidy sum.

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Over the past two years, the FTSE 100 has grown around 14%. If you taken out a FTSE index tracker a couple of years ago, you would be happy enough with your growth, especially with dividends on top.

But if you had bought Lloyds then you would be a lot happier, having pocketed a whopping 62% growth, and nearly 50% from Barclays plus dividends. Although RBS would have given you just 1%.

Laugh out Lloyds

Over one year, you would be even happier. The FTSE 100 grew nearly 16% in that time, but RBS shrugged off its share-price struggles to return 57%, Barclays delivered 93%, while Lloyds grew an almighty 131%. All three banks also thrashed the FTSE 100 over the past three months, as the box shows.

Time scale FTSE 100 Barclays Lloyds RBS
Three months 5.2% 10.72% 47.5% 19.22%
One year 15.7% 93.03% 131.7% 57.51%
Two years 14.2% 49.83% 62.33% 1.06%
Three years 28.7% 11.13% 18.15% -23.23%

The banks aren’t pure little value pays. Frankly, they’re a punt. Investors who gambled their money may have hit the jackpot but can their winning streak continue?

Big and ugly

If you buy a bank now, you are buying a mountain of uncertainty topped by a rockfall of risk. You never know where the next mis-selling scandal is coming from, but they seem to arrive by the day. PPI mis-selling, Libor-rigging, energy market-manipulation… billions of pounds worth of penalties keep rolling in, and litigation risk is constant.

So yes, the banks are ugly behemoths, but they are also unslayable. Politicians, regulators and central bankers may chain them down with capital requirements, reserve requirements, corporate governance, financial reporting and disclosure requirements, but they daren’t kill the beast. Chancellor George Osborne is even relying on them to bolster the Conservative re-election campaign, as he prepares to privatise Lloyds.

At 69p, Lloyds is currently trading above the taxpayer break-even point of 61.2p. Even Invesco Perpetual’s Neil Woodford is rumoured to be considering buying a stake, despite his well-known antipathy to banking stocks. Various sovereign wealth funds are also said to be lining up bids, so maybe offloading the taxpayer’s stake won’t be as injurious to the share price as we all expected. Dumping RBS will take a little longer, and it may even be broken up, adding a good deal more investor uncertainty.

BARC or bite?

Trading at 9.1 times earnings, and with no privatisation to muddy matters, Barclays looks like the bank to buy. If you are planning to hold for at least five years, you will surely make money on this stock, although I wouldn’t expect a repeat of recent market-busting performance.The dividend may be just 2.3%, but that is forecast to rise to 3.1% by December 2014, and further increases will surely follow. Forecast earnings per share (EPS) growth of 20% in 2014 look tempting.

Barclays may struggle to repeat recent market-busting performance, but I would still expect it to outperform as the recovery kicks in. I highlighted a buying opportunity on 4 July, after Barclays had dropped to £2.81. A fortnight later it costs £3.19, a rise of 13.5%. Would you bet against it going any higher?

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> Harvey holds shares in RBS. He doesn’t own any other stock mentioned in this article

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