2015 has been a truly astounding year for investors in Virgin Money (LSE: VM), with its shares rising by a whopping 55% since the turn of the year. This has made the market wake up to the potential that the so-called ‘challenger’ bank has, as well as the fact that there are more options available to investors seeking exposure to the banking sector than the ‘old guard’.
This old guard includes Barclays (LSE: BARC) (NYSE: BCS.US), which has been a relatively strong performer in recent years in terms of its financial figures. In fact, unlike a number of its peers, it required no government bailout and has remained profitable throughout the last five years. Looking ahead, though, can Virgin Money continue to eat up the market share of banks such as Barclays? And, as a result, is it a better buy than its better established peer?
While challenger banks such as Virgin Money have performed relatively well in recent years, they have enjoyed very favourable trading conditions. For example, the last few years have seen the UK economy quickly transition from an underperformer to one of the fastest growing economies in the developed world. This has caused consumer confidence to improve dramatically in a relatively short space of time and, with an ultra-loose monetary policy lifting asset prices and driving down the cost of borrowing, demand for new loans has risen and defaults on existing loans have moderated.
As such, it has been a great time to be a new entrant to the banking sector and, with Virgin Money not having many of the legacy problems that banks such as Barclays have faced (such as allegations of wrongdoing, PPI claims and fines), it has been free to get on with the simple task of lending.
However, the real challenge will come when there is a downturn and UK economic performance is less optimal than at present. Then the size and scale of Barclays could be a major plus and provide it with more consistent financial performance. Furthermore, the cross-selling opportunities that Barclays and its larger peers currently enjoy could prove to be a greater differentiator during more challenging periods for the sector.
For example, Barclays provides various loss-leading services (such as current accounts) that provide it with a long list of potential customers for the sale of loans and other profitable activities. Virgin Money, on the other hand, does not enjoy the same degree of cross-selling opportunities and so must rely on highly attractive savings and borrowing rates in order to generate new business. And, during more challenging periods, this could cause its profitability to come under pressure.
Clearly, sentiment in Virgin Money has been very strong in 2015 but, looking ahead, further share price growth is very much on the cards. For example, it trades on a price to earnings growth (PEG) ratio of just 0.3, which indicates that growth is on offer at a very reasonable price.
However, while Barclays’ share price has risen by a rather lowly 8% this year, it trades on the same PEG ratio as Virgin Money, and so offers tremendous upside over the medium to long term. This, coupled with its size, scale and excellent track record of profitability make it the pick of the banking sector so that, while Virgin Money is a stock well-worth owning, Barclays has greater appeal at the present time.
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Peter Stephens owns shares of Barclays. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.