This May Actually Be The Time To Buy Royal Bank of Scotland Group plc

rbsYou know what puts me off investing in Royal Bank of Scotland (LSE: RBS) (NYSE: RBS.US)? It’s not the furore over things like the PPI scandal, bankers’ bonuses or such like.

What puts me off is the sheer complexity of RBS and its balance sheet. Warren Buffett said you should only invest in things you understand. And I’m not sure I fully understand RBS’s balance sheet.

A broad brush view of the company

So I am taking a broad brush view of the company. I see RBS as the BP (LSE: BP) (NYSE: BP.US) of the banking world. The calamity that struck in 2007 as the era of cheap credit ended in dramatic fashion, just as RBS was taking over ABN Amro, was every bit as devastating as when the Deepwater Horizon oil rig exploded in the Gulf of Mexico, causing millions of gallons of oil to spew into the ocean.

Both companies have suffered staggering losses. RBS’s total losses so far from the financial crisis amount to some £46 billion. BP’s total losses from Deepwater Horizon amount to over £30 billion, with litigation still ongoing.

How can you react to such incredible losses? Well, these companies have acted in the only way they could: by selling off substantial parts of their business, to pay off these losses. This was basically the only way these companies could raise the sums of money required to pay these losses.

A simple idea

The idea is simple: the amount of the company you sell off should match the total losses. Through these sales the company will, eventually, clear the losses. The resulting business will be smaller, and correspondingly less profitable. So the share price will be less. But the business you are left with should be a profitable, stable concern which is set fair into the future.

So what about the implementation? Well, BP has so far sold £27 billion of assets, including much of its US business, refineries and a range of other assets scattered around the globe.

RBS is selling its US retail business Citizens, and a UK retail business, Williams & Glyn. It has already sold Direct Line and 314 bank branches, and tens of thousands of jobs have been shed.

But there are also other demands on these businesses. BP is finding that oil is less plentiful and more expensive to extract. RBS has a range of strict capital requirements it has to adhere to, such as its core tier 1 ratio. Plus there have been scandals such as PPI.

And then, of course, there is the reputational damage that both of these companies have suffered.

Overall, it has been a chastening experience for both companies. And yet, you might be surprised to hear, I am cautiously optimistic about the future of these companies.

BP is on a P/E ratio of 9. RBS is on a 2014 P/E ratio of 15, falling to 10 the following year. Neither looks expensive. In particular, after so many false dawns, I suspect that RBS’s profitability is just beginning to turn. If that’s the case then, amid all the gloom, this might actually be the time to buy RBS.

Our guide to investing in the banks

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Prabhat owns shares in none of the companies mentioned in this article.