Barclays PLC, Lloyds Banking Group PLC & Royal Bank of Scotland Group plc: Should You Buy Shares That Rise On Bad News?

Piggy bankRipping off the Bank of England, collapsing profits, zero growth — three examples of bad news that has triggered share price gains for Barclays (LSE: BARC) (NYSE: BCS.US), Lloyds Banking Group (LSE: LLOY) and Royal Bank of Scotland Group (LSE: RBS) (NYSE: RBS.US) over the last week or so.

What happened?

Lloyds accepted a fine of £218m for manipulating interest rates, including the rate paid on its emergency funding from the Bank of England: one day later, the bank’s share price was up.

Barclays unveiled a 7% fall in adjusted pre-tax profits, largely driven by a 46% drop in income from its investment bank.  The bank’s return on equity fell, the interim dividend was unchanged, and Barclays reported a further £900m of PPI provisions. Yet the bank’s share price rose by almost 5% in the first two hours of trading today.

Finally, there’s RBS: the bank’s reduction in impairments was good news, but it may not be sustainable, and disguises the fact that the bank isn’t growing — underlying profits were unchanged. RBS remains several years away from achieving the level of recovery seen at Lloyds, but RBS shares also rose after this ‘good news’, closing up by 11% that day.

The explanation for these banks’ share prices rising on bad news is fairly simple: markets hate uncertainty, and fear bad news.

In each case, the banks’ most recent updates helped to reduce uncertainty and put a floor under negative expectations.

Are these banks a buy?

When a firm’s share price bounces on bad news, it can sometimes be a buying opportunity; a sign that the bad news is already in the price.

Given this, are any of these three banks worth buying at today’s prices?

Bank 2014 forecast P/E 2014 prospective yield
Barclays 10.2 3.3%
RBS 14 0%
Lloyds 10.6 1.8%

Source: Consensus forecasts

On the face of it, RBS still looks unappealing. RBS shares no longer trade at a significant discount to their tangible book value, and the bank’s P/E of 14 looks optimistic, given that a dividend payment is still at least a year away, possible more.

However, Barclays and Lloyds look more promising, and I personally rate both banks as buys.

Barclays’ turnaround has a long way to run, but the bank’s current valuation reflects this, with a discount to book value, a reasonable yield, and an undemanding valuation.

Lloyds, on the other hand, benefits from a simpler business that’s expected to deliver decent profit growth this year, along with its first dividend payment since 2008.

Testing the banks' recovery

To some extent, all three of these banks are still working through their recovery plans. Before investing in any of them, I would recommend a closer look at each bank's key valuation ratios.

In "The Motley Fool's Guide To Investing In Banks", each of these banks is analysed in more detail, using six key valuation metrics that will tell the story of each bank's recovery in an easily understandable format.

I rate this report as essential reading for all banking investors -- to receive your FREE, no-obligation copy today, simply click here now.

Roland Head owns shares in Barclays. The Motley Fool has no position in any of the shares mentioned.