Shares in Royal Bank of Scotland Group (LSE: RBS) (NYSE: RBS.US) look expensive at 341p.
The firm’s most recently reported net-asset-value-per-share figure is 376p, so RBS is disguised as a bargain. Don’t let the costume fool you; a number of factors work against any investment in the bank today.
Not growth, just the onset of normality
Looking at quarter one’s trading results, I see that profits are well up. They need to be. For many years, profits have been well down. In fact, the firm has made losses counted in billions. So a return to profitability now doesn’t presage a new era of growth, it just means the firm is dragging itself back onto its feet.
Markets know all about the cyclicality of profits in the banking sector. That’s why, as profits grow in maturing economic cycles, the P/E ratings of the banks shrink. It’s a powerful current flowing against total investor returns at this stage in the game. Of course, the market is trying to predict the next profit collapse. Indeed, when P/E ratings are low and dividend yields high, banks look their most attractive to value- and income-hunting investors, just like a Venus Flytrap does to a fly before it eats it.
As the cycle down dips, profits will fall and the share price will plummet. When will that be with Royal Bank of Scotland? I don’t know and, for me, that’s a very good reason not to invest in the bank right now.
Legacy pain
The unpredictability of RBS’s cyclical behaviour isn’t the only reason to stay clear. Pre-credit crunch, the bank’s ego-driven balance sheet bubbled up to a highly geared £800 billion, give or take a bit. The bubble burst, leaving the firm reeling from the blow. The pain of unwinding such an over-pumped asset position continues to throb. For example, cash performance struggles:
| Year to December | 2009 | 2010 | 2011 | 2012 | 2013 |
|---|---|---|---|---|---|
| Net cash from operations (£m) | (992) | 19,291 | 3,325 | (45,113) | (30,631) |
| Net cash from investing (£m) | 54 | 3,351 | 14 | 27,175 | 21,183 |
| Net increase/decrease in cash (£m) | 9,261 | 8,344 | 125 | (19,814) | (11,664) |
And net assets shrink:
| Year to December | 2009 | 2010 | 2011 | 2012 | 2013 |
|---|---|---|---|---|---|
| Net assets (£m) | 94,631 | 76,851 | 76,053 | 70,448 | 59,215 |
The CEO aims to make RBS “the most trusted bank in the UK,” which strikes me as a goal of huge ambition given the flow of conduct-related issues that have emerged since the financial crisis such as LIBOR, PPI, interest rate swaps and RMBS litigation. The bank itself admits, “ongoing conduct and regulatory investigations and litigation continue to create challenges and uncertainties for RBS, as for other banks. The timing and amounts of any further settlements or redress remain uncertain.”
All of which leads to another reason for avoiding an investment in RBS: the operations of banks are hard to analyze. Heck, they don’t even know themselves what will happen next, so what sound basis is that for an investment?
What now?
I can’t see the need to risk including the big London-listed banks in any well-balanced portfolio: not for income diversification nor for capital growth. There are way too many unknowns and we must think of the first tenet of money management: preserve capital.
