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How Royal Bank Of Scotland Group plc Could Surge 76% In 5 Years

The shares of Royal Bank of Scotland (LSE: RBS) (NYSE: RBS.US), currently trading at 325p, have fallen 31% over the last five years, massively underperforming the FTSE 100, which has gained 53% in that time.

However, the story could change over the next five years, as RBS’s shares have the potential to advance by 76%.

Here’s how

rbs

Bailed-out bank RBS has gone through a massive restructuring since the financial crisis, and there’s still a lot of work to do. The creation of an internal ‘bad bank’, to exit or run down the group’s riskiest assets, has contributed to further short-term pain. Impairments contributed to a pre-tax loss of more than £8bn for 2013.

However, there’s light at the end of what has been a long, dark earnings tunnel. RBS posted a pre-tax profit of £1.6bn for the first quarter of 2014, and City analysts are forecasting positive earnings per share (EPS) for the full year. The consensus is for 22.7p, albeit individual forecasts range widely around that number.

The analysts are expecting to see EPS continue growing strongly thereafter, through to a consensus 35.7p by the year ending December 2018. That would represent a very decent four-year compound annual growth rate of 12%.

Such an outcome would imply RBS had made great strides towards a full recovery. As such, we could see the stock re-rate to the FTSE 100’s long-term average historic P/E of 16. If so, the shares would be trading at a bit over 571p — a 76% gain on today’s price.

As well as a return to positive EPS, analysts are expecting dividends to resume — and to start growing fast. The consensus is for a total dividend payout of 45.6p over the period. Put another way, a £1,000 investment in RBS today would deliver £140 in dividends.

However, HSBC, a bigger and surely safer bet than RBS, is slated to deliver even better returns, if the City experts’ forecasts play out, and HSBC also re-rates to the FTSE 100’s long-term average P/E.

My calculations suggest HSBC could rocket 138% over five years, and pay out a whopping £320 in dividends on a £1,000 investment today.

This suggests to me that there’s a fair bit of RBS’s forecast recovery already in the share price, and that analysts’ earnings projections would have to rise significantly to make RBS a more attractive proposition than HSBC, as things currently stand.

There's no guarantee that earnings and dividends of either bank will pan out, of course. However, history tells us that companies are capable of delivering the kind of return I've outlined here -- or even higher.

Which is one reason why here at the Motley Fool we believe the average private investor can aspire to build a £1 million portfolio.

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G A Chester does not own any shares mentioned in this article.