Is Standard Chartered plc A Promising Capital-Growth Investment?

Standard CharteredAsia-focused banking company Standard Chartered (LSE: STAN) (NASDAQOTH: SCBFF.US) steams with the odour of growth potential and has done for as long as I can remember. It’s easy to see why.

Last year the firm earned about 82% of its operating profit from Asia and 10% from Africa, two up-and-coming markets that seem ‘certain’ to grow in the years ahead. Standard Chartered reckons that by 2030, Asia will add more than 2.2 billion people to the world’s middle class, raising that region’s share of the global total to 66 per cent.

The potential seems enormous, and Standard Chartered has a long tradition in the region. But is banking the best way to play emerging markets? I don’t think so, and here’s why:

Difficult trading

The trouble with banks is that their trading results tend to fluctuate with the general macro-economic conditions prevalent in the areas in which they operate. We saw a dramatic example of this inherent cyclicality for all banks in the wake of the credit-crunch.

However, such cycles aren’t always as startling. Right now, Standard Chartered is finding trading difficult in some of its core markets and last month warned that first-half income from its Financial Markets operations is down 20%. Other lines of business remain in-line with management’s expectations, but the weakness in Financial Markets shows how much of the trading outcome for banks is beyond managements’ control.

Disagreement of trading and share-price action

Looking at Standard Chartered’s record of trading, the bank seems to be recovering well since the worldwide financial crisis:

Year to December 2009 2010 2011 2012 2013
Operating profit ($m) 5,130 6,080 6,701 8,061 8,584
Net cash from operations ($m) (4,754) (16,635) 18,370 17,863 9,305

So, over the period shown we might expect the share price to have risen gently to reflect the improving financial results. But it hasn’t. Instead, there was a big lurch up from the credit-crunch nadir in early 2009 to a peak achieved at the end of 2010. Since then, there’s been a noisy trend down.

If you look at the share price charts of other banks, you’ll see a similar picture. So what’s happening?

Cyclicality sussed

There’s nothing new about cyclicality and the market as a whole sussed it out decades ago. So it tends to account for it. The stock market is a forward-looking beast and knows that, sooner or later, Standard Chartered’s profit and cash flow progress will reverse as general economic conditions deteriorate again. It may not be as ferocious as the last credit-crunch, but the current period of economic sunshine will set, as it always has.

So, as profits rise for the banks, towards the next peak, the stock market compresses the valuations of the cyclical companies in anticipation of the next profit trough. If we look at the cyclical companies, such as banks, we can see this phenomenon playing out right now. It’s a dynamic that works against capital gain for investors no matter how well a bank is increasing profits from year to year on the cyclical up-leg.

It’ll take a mighty surge in business performance to move Standard Chartered’s share price up sufficiently to overcome these cyclical share-price behaviours, and that’s why I don’t think Standard Chartered is a promising capital-growth investment at the moment.

What now?

This is not the best time to be in cyclicals like Standard Chartered in my view, which is why I'm looking at three other companies that look set to do well this year. In fact, the Motley Fools top team of share analysts reckons these three could be among the best picks for 2014 and beyond.

One company is a largely ignored small cap. There's a play on technology focused high-tech defence applications, and the third provides a vehicle to ride emerging-market potential.

I'm glad to have the Fool analysts' sign-posting report on my side.  It's free for a little while longer. Find out more by clicking here.

Kevin Godbold has no position in any shares mentioned. The Motley Fool owns shares of Standard Chartered.