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As The Government Sells, Should You Be Buying Lloyds Banking Group PLC & Royal Bank of Scotland Group plc?

On Friday, the UK government sold another £70m of shares in Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US), reducing its holding in the bank to less than 23%.

In a recent interview with the FT, Chancellor George Osborne said he would like to “get rid of” the government’s 79% stake in Royal Bank of Scotland Group (LSE: RBS) (NYSE: RBS.US) “as quickly as we can” after the general election.

The mood is clear: the government wants to sell its banking shares, preferably for a modest profit. In this article, I’ll take a look at whether I believe private investors should be buying Lloyds and RBS in the current market.

Lloyds

Analysts are bullish on Lloyds, and the bank currently trades on a 2015 forecast P/E of just 10, despite Lloyds’ shares trading at 81p — within a whisker of last year’s post-2009 high of 85p.

Lloyds has now restarted dividend payments, and will pay 0.75p per share to shareholders for the 2014 financial year.

Although this only provides a yield of 0.9% at today’s share price, Lloyds’ medium-term intention is for the payout ratio to rise to 50% of sustainable earnings — and consensus forecasts suggest a payout of 2.8p is likely in 2015, giving a prospective yield of 3.5%.

In my view, Lloyds is returning to its roots as a cash generative, conservative UK bank: for income investors, now could be a good time to buy.

RBS

RBS’s recent full-year results were uninspiring, and triggered an 8% slide in the bank’s share price.

Returning RBS to private ownership won’t be simple, either. The government needs to sell £45bn of shares at an average of 455p per share in order to break even. That’s around 20% above today’s share price.

However, RBS is making big cuts to its investment banking operation and is focusing on becoming a UK retail bank — essentially similar to Lloyds. Successful delivery of this strategy could help cut costs and boost earnings faster than expected.

In terms of valuation, RBS looks slightly more expensive than Lloyds, on a forecast 2015 P/E of 12.5. However, unlike Lloyds, RBS shares trade slightly below their tangible book value, and I believe this discount offsets the risk implied by the higher P/E rating.

Ultimately, I see Lloyds as a decent income buy, but I believe RBS could deliver bigger gains for investors over the next 3-5 years.

However, banks remain complex and risky investments, and if you already own banking stocks, you may want to look elsewhere for your next buy.

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Roland Head has no position in any shares mentioned. 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.