Why I’d Sell Royal Bank of Scotland Group plc And Buy Lloyds Banking Group PLC

Our two bailed-out FTSE 100 banks, Lloyds Banking Group (LSE: LLOY)(NYSE: LYG.US) and Royal Bank of Scotland (LSE: RBS)(NYSE: RBS.US), have been on similar valuations for the past year or so, and I’ve never really understood why.

In fact, RBS shares are on higher forward P/E valuations than Lloyds, despite the latter being about a year ahead of RBS in its recovery — we’re looking at forecast multiples of 12 and nearly 14 for RBS for this year and next, with Lloyds shares more lowly rated on P/Es of under 11.

Better dividends

Lloyds is way ahead in the dividend stakes too, having paid 0.75p per share in the second half of 2014 and with yields of 3.3% and 4.8% forecast for 2015 and 2016 respectively. If RBS manages to hand out cash this year it’s only expected to yield 0.4%, with a modest 1.5% on the cards for 2015.

Is RBS’s liquidity position better? It doesn’t appear to be, no. At first-quarter time at the end of March Lloyds reported a CET1 ratio of 13.4%, which was a fair bit ahead of the Q1 figure of 11.5% reported by RBS. Impairment charges in the quarter looked a little bit better at RBS, with only £91m compared to £177m at Lloyds, but both are small compared to the banks’ longer term profit expectations and both are falling nicely.

Lloyds’ CEO António Horta-Osório remained upbeat, saying “I am pleased with the continued improvement in financial strength and performance in the first quarter and expect our plan to deliver sustainable growth and improved returns“, and on the showing so far it’s hard not to agree.

Lloyds picking up

Lloyds’ undervaluation does at least seem to be getting noticed now, as the shares climbed when those Q1 figures, showing a 21% increase in underlying profit and flat total costs, were released. We also had a post-election spike, taking the price up to 88p as I write — and up 13% over the past 12 months. But even after that, they still look like the better bargain of the two.

RBS shares are slightly up over the past year, gaining 7% to today’s 354p, but the optimism has been reversing of late — despite a similar election boost, the price has slipped back by 13% since its recent peak on 24 February.

Better forecasts

Forecasts are strengthening at Lloyds too, and there’s a pretty bullish Buy consensus from the City’s analysts right now, compared to a significantly more bearish outlook for RBS with more pundits suggesting we should Sell. And I’m with them — if I had RBS shares now I’d be selling them, and I reckon Lloyds would be a great place for the cash.

A FTSE 100 bank like Lloyds can provide a cornerstone for a successful blue-chip portfolio, using a simple approach which can bring great long-term rewards.

To find out more, get yourself a copy of the Motley Fool's special 7 Simple Steps For Seeking Serious Wealth report, which shows you how investing in shares and reinvesting dividends has wiped the floor with every other form of investment over the past century and more.

It's completely FREE, so click here for your personal copy and get started today.

Alan Oscroft 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.