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What’s Next For Barclays PLC & Lloyds Banking Group PLC?

Risk control plays an important part in investment strategies, even more so these days if you are invested in Barclays (LSE: BARC) and Lloyds (LSE: LLOY) — two banks whose shares seem to be more than fairly priced at present. 

Barclays 

Barclays has traded in the 201p–276p range over the last 12 months, and now changes hands at 258p. 

Since a low of 207p in mid-October 2014, when the FTSE 100 hit its one-year trough of 6,072 points, Barclays has gained 24.6% of value, which implies a forward valuation of 15x, based on its price to net earnings multiple, and a dividend yield of 3.1%. 

Barclays may sound a good investment at this price, but there’s a problem — namely, growth forecasts for its core margins. 

Margins

Between 2009 and 2014, Barclays’ net income margin and  operating income margin both dropped significantly on a reported basis, down from 38% and 30%, respectively, in 2009, to 29% and -0.6% in 2014. 

Its aggregate reported net losses between 2012 and 2014 amount to over £600m, as several so-called non-cash items impacted its bottom line.

You might know this part of the story.

What you may have missed, though, is that estimates from analysts — who must stick with the guidance provided by their clients  — point to rising earnings and growing underlying operating profit, but there’s no evidence, in my view, that its cost and cash flow ratios and its returns metrics will allow it to become a bank that’s able to generate almost £12bn of aggregate net income between 2015 and 2017.

Most of the upside, of course, is predicted in 2016 and 2017, when the bank is forecast to report a level of profitability that it hasn’t recorded since 2009. In 2016 and 2017, estimates suggest a combined operating income of about £22bn for those two years alone, which would equate to the amount that Barclays generated over the last three years of business.

If that’s the case, be prepared to read about thousands of job cuts in the months ahead. 

Finally, once additional non-cash items are considered, its shares are up to 30% more expensive than its share price currently suggests. 

Lloyds, however,  is a different story. 

Lloyds

At 84p, Lloyds trades only 4% below its 52-week high of 89.3p, reached on 3 June.  Most of its one-year gains hinge on its recent performance in May, when it benefited from a strong quarterly trading statement and a positive outcome for banks from the General Election. 

Just like Barclays, Lloyds is not expected to generate significant revenues growth over the next three years, but its net income margin is projected to rise from 6% to 30% between 2014 and 2017. While its operating income is not expected to grow much over that period, its aggregate net income is expected to come in at £14.5bn — which seems a lot if you consider that Lloyds reported £1.1bn of aggregate net losses between 2009 and 2014 in a similar interest rate environment. 

Of course, Lloyds may have turned the corner, and its earnings may have bottomed out three years ago, but I am not convinced its stock is a compelling choice right now. 

To invest in this market, where interest rates are unlikely to grow at a fast pace, revenue growth is an important component, so I'd also avoid Barclays and I'd rather pick up a terrific small-cap identified by our Motley Fool analysts point out in a brand new report.

It's your call, and you should do your homework before deciding where to invest in it or not, but in my opinion, this FREE report could help you determine the fair value and the full upside of a sound business whose shares have sky-rocketed in recent years. 

Its prospects and its identity can be found here for free but only for a limited amount of time! 

Alessandro Pasetti 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.