For many investors, the banking sector is off-limits. This could be because of the poor performance of banking shares over the last decade, with a number of stocks in the sector such as Northern Rock going bust, or may be because of the unrelenting regulatory action (i.e. fines) that has become an everyday part of life for the banks.
Of course, neither of these reasons can be denied and life as an investor in bank shares has been tough. However, it’s time to reconsider the sector’s future potential, since at a time when the FTSE 100 is trading close to its all-time high and there are concerns about emerging market growth, the banking sector could provide the perfect mix of growth and value.
Take, for example, RBS (LSE: RBS) (NYSE: RBS.US). It is far from being back to full health and, in reality, is unlikely to do so for a number of years. However, this does not mean that its shares will not begin to price in its improved financial health in the meantime – especially as the government gradually reduces its stake in the coming years.
As such, and while RBS may still be struggling to post impressive growth numbers, its shares are worth buying for their turnaround potential and the prospect of an upward rerating. For example, RBS currently trades on a price to earnings (P/E) ratio of just 13.3, and this indicates that its share price could move higher over the medium term.
It’s a similar story with HSBC (LSE: HSBA) (NYSE: HSBC.US). Certainly, its exposure to the Far East may hold back sentiment in the meantime, with China enduring a prolonged soft landing. However, in the long run this position should work to the bank’s advantage and, in the meantime, a strategy shift has the potential to boost investor sentiment.
In fact, HSBC’s immediate future is set to be focused on reducing costs and generating efficiencies, since its operating costs have spiralled in recent years. And, as with RBS, there is significant upside built into its share price, with HSBC trading on a price to book (P/B) ratio of just 0.86. This shows that, while its margins may continue to be squeezed in the short run, HSBC offers significant upside in the long run, during which time it is likely to have successfully reduced its cost base.
Of course, there are banks with strong near-term prospects, too. A prime example is Virgin Money (LSE: VM), with its pretax profit set to rise from £34m last year to £205m next year. That’s a staggering rate of growth and shows that, while the likes of HSBC and RBS may have challenges to overcome in the short run, Virgin Money’s greater flexibility and more nimble business model could deliver exceptional profit growth.
Despite this, Virgin Money trades on a P/B ratio of just 1.6, which indicates that its shares are not expensive and that strong profit growth could lead to exceptional share price performance. As such, Virgin Money (alongside RBS and HSBC) appears to be well-placed to outperform the FTSE 100 over the medium to long term.
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Peter Stephens owns shares of HSBC Holdings and Royal Bank of Scotland Group. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.