Why I’d Rather Stick With Barclays PLC Than Buy Virgin Money Holdings (UK) PLC

Having delayed its planned listing due to volatile market conditions, Virgin Money (LSE: VM) listed today at a price of 283p per share and, at the time of writing, seems to have made a steady start.

Challenger Bank

Virgin Money’s entry into the UK banking sector came about via the purchase of part of Northern Rock in 2011 for a price of £747 million. Of course, this purchase did not include the so-called ‘bad assets’ that were switched to Northern Rock Asset Management and are not part of Virgin Money.

Although the Treasury received only half of the investment it made in Northern Rock when it became nationalised in 2008, the idea behind the sale was at least partly to try and create more competition in the UK banking sector. Indeed, it remains dominated by a handful of banks, including Barclays (LSE: BARC) and, as such, it is felt that challenger banks, such as Virgin Money, can offer consumers more choice.

The Problem

The difficulty is, though, that banks such as Barclays have a huge advantage when it comes to size and scale. This allows them to offer loss-leading products in order to increase their customer base, before cross-selling various products and services to happy and loyal customers. For example, Barclays (and other incumbent banks) offer free current accounts.

While these are loss-makers, they provide a superb list of customers that are already familiar with the Barclays brand and are generally happy with the service they receive. As such, many of them decide to ‘play it safe’ with products such as mortgages, loans and investment products because they think it is not worth taking the risk with a bank that is relatively unknown to them. As a result, it’s extremely difficult for the challenger banks to make a real impression on the industry without resorting to offering relatively high savings rates (which reduce profit margins), for instance.

Looking Ahead

While this situation may ease somewhat over the long run, Barclays remains a compelling investment opportunity right now. Not only does it offer investors superb growth prospects, with earnings set to rise by a hugely impressive 23% in the current year, and by a further 28% next year, it also trades on a super-low valuation that indicates upward share price movements are very much on the cards.

For instance, Barclays has a price to earnings (P/E) ratio of just 11 and a price to book ratio of only 0.67. These figures seem difficult to justify when Barclays is so profitable and has such impressive growth potential. And, with its position as a dominant player in the UK banking scene unlikely to come under real pressure over the medium term, I’d much rather stick with owning shares in Barclays than buying a slice of Virgin Money.

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Peter Stephens owns shares of Barclays. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.