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My Top 3 Banks For 2015: Barclays PLC, Lloyds Banking Group PLC And Royal Bank Of Scotland Group plc

 

On the day when it has been announced that Britain’s biggest banks are set to be subject to an 18-month investigation into how they treat their small business and personal customers, shares in Barclays (LSE: BARC) (NYSE: BCS.US), Lloyds (LSE: LLOY) (NYSE: LYG.US) and RBS (LSE: RBS) are down just over 1% apiece.

Of course, the investigation could peg back sentiment in all three banks during the course of 2015 and cause their share prices to disappoint somewhat. Furthermore, it could lead to break-ups of the major banks as the competition and markets authority seeks further choice for consumers when it comes to their banking needs.

However, I’m still bullish on the prospects for the wider banking sector and particularly for Barclays, Lloyds and RBS. Here’s why.

Valuations

While the future remains a highly uncertain time for the UK’s major banks, as shown by the announcement of today’s investigation, their current valuations appear to be unjustifiably low. Indeed, the price to earnings (P/E) and price to book ratios for the three banks are extremely low. In the case of RBS and Barclays, they trade at far less than net asset value, with the former having a price to book ratio of just 0.4 and the latter’s being 0.7.

Even Lloyds’ price to book ratio of 1.4 is still hugely appealing despite being much higher than that of its two key rivals. Indeed, such low valuations were perhaps understandable during the financial crisis but, with the UK economy moving from strength to strength and now being the fastest growing economy in the developed world, dirt cheap share prices for the banks are unlikely to last over the medium to long term.

Furthermore, it’s a similar story when focusing on the P/E ratios of Barclays, Lloyds and RBS. While the FTSE 100 has a P/E ratio of 13.9, my top three banks for 2015 trade on ratings of just 10.8 (RBS), 11.3 (Barclays) and 9.7 (Lloyds). Therefore, there seems to be tremendous scope for upward reratings over the medium term – especially with profitability set to increase as a result of a an improving macroeconomic outlook.

Looking Ahead

As well as being cheap and having bright prospects, RBS, Barclays and Lloyds all have significant income potential. While dividends are rather difficult to come by, with Barclays the only one of the three currently paying a dividend, expected increases in profitability combined with improving capitalisation rates mean that shareholder payouts could rise at a rapid rate.

Furthermore, with all three banks aiming to deliver generous payout ratios over the medium term, with Lloyds for instance setting itself a target payout ratio of 65% in 2016, dividend prospects for investors look very bright.

So, while sentiment may well remain weaker than anticipated over the course of 2015, with investigations, PPI claims and currency probes weighing on investors’ minds, RBS, Barclays and Lloyds could still deliver excellent share price gains. Indeed, their mix of value, income potential and improving bottom lines could prove to be a highly potent one.

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Peter Stephens owns shares of RBS, Barclays and Lloyds Banking Group.