With the Competition and Markets Authority stating last week that it is considering an investigation into the UK banking sector, ‘challenger’ banks are on the agenda once more. Indeed, with the likes of Barclays (LSE: BARC) and Lloyds (LSE: LLOY) providing over three-quarters of current accounts in the UK at present, it appears as though there could be an opportunity for so-called ‘challenger’ banks to muscle in on the action.
A New Era?
Certainly, the banking sector looks set to enjoy a more prosperous future than past. For instance, Lloyds is set to return to profitability this year for the first time since before the worst of the credit crunch, while Barclays continues to deliver strong bottom-line growth, with earnings per share (EPS) forecast to increase by 39% in the current year.
However, there could also be potential outside of the likes of Barclays and Lloyds. For instance, Santander (LSE: BNC) offers a potent mix of strong growth potential and a great yield. It currently trades on a yield of 7.8% and is expected to increase EPS by 23% in the current year and by 20% next year. Certainly, investors are being asked to pay a fairly hefty price for such growth, with shares in Santander currently trading on a price to earnings (P/E) ratio of 14.8. This is higher than the FTSE 100‘s P/E of 13.9 and shows that even bank shares can become highly rated once performance picks up.
Meanwhile, TSB (LSE: TSB) does not offer investors a dividend (and is not expected to until 2017), but trades on a lower P/E than Santander of 12.1. One attraction of the bank to investors taking part in the IPO, however, was a ‘free’ share for every 20 they purchased, which is designed to compensate them for a lack of dividend. Purchasers in the secondary market, though, do not receive that bonus, but they should still benefit from the stability of the new bank being reasonably strong given that it is set to use many of Lloyds’ internal systems over the short to medium term.
Clearly, there is great value on offer in the banking sector, with TSB trading at a 13% discount to the wider market and Santander continuing to offer good value given its strong growth prospects. Indeed, the choice over which to buy appears to hinge on an individual’s preference for value over growth, or growth over value, with both companies having the potential to deliver strong returns over the long run.
Peter Stephens owns shares in Barclays, Lloyds and TSB. The Motley Fool has no position in any of the shares mentioned.