Lloyds Banking Group PLC, Barclays PLC, Banco Santander SA: Which Is Best For 2016?

I’ve thought for some time that our top listed banks are undervalued right now, with share prices very likely still depressed by ongoing fears from the financial meltdown. I do think there are strong reasons to avoid both HSBC Holdings and Standard Chartered. And Royal Bank of Scotland still looks overpriced for its relatively slow recovery, but the remaining big three look good to me.

Set for a comeback 

I’ll start with the most unusual first, Spain-based Banco Santander (LSE: BNC). Santander is going through a transformation to what would be considered a normal dividend regime by most Western observers. In the past, the bank has been paying very high dividend yields that were not covered by earnings, but it managed to do that because a large number of Spanish investors would take scrip instead of cash — although that, of course, dilutes future earnings.

Today, Santander is on an expected dividend yield for the year just ending of 3.9%, forecast to rise to 4.3% in 2016. That would give us P/E multiples of around 9.5 this year, dropping to 9 next. With earnings set to grow modestly after two years of very strong growth, that makes the shares look attractive to me — after falling 38% this year, to 336p, Santander could be set for a comeback.

Britain’s strongest?

Barclays (LSE: BARC) shares have lost 8.5% this year, dropping to 220p, though they’ve picked up a little since their mid-December low. That leaves them on a P/E of just over 10 this year, dropping to 8.5 in 2016, as EPS is expected to show two years of gains above 20%.

I’ve always considered Barclays to be perhaps the UK’s strongest bank — it escaped a bailout during the crisis by attracting private capital, and has since been comfortably able to pass the Bank of England’s stress tests.

I have Barclays shares in the Fool’s Beginners’ Portfolio (though that is not real money), and although they haven’t done much so far, I can easily see 2016 as being a transformational year for Barclays — I recently opined that there could be an upside of as much as 65% in the relatively short term.

Barclay’s dividend yields are still modest at an expected 2.9% this year, followed by 3.6% next, but they’re strongly progressive.

Best of the lot?

Then I come to my own favourite, Lloyds Banking Group (LSE: LLOY), which is the one I’ve chosen for some of my own money. Lloyds shares have dipped by 2.4% in the year so far (with just a few hours left), to 73p. It’s true that EPS forecasts for this year and next aren’t fantastic — a 3% lift this year followed by an 8% fall — but the killer for Lloyds is its dividend.

Lloyds obtained approval to resume handing out cash in the second half of 2014 with a very modest 0.75p per share, which was well ahead of bailed-out rival RBS. Now we’re on for a yield of around 3.3% this year, rising to a twice-covered 5.1% next year. P/E multiples come in at under nine, rising only as far as 9.5 in 2016, and I reckon that’s way too low.

The overhang caused by the government’s stake in Lloyds that is being steadily sold off probably accounts for the depressed share price, but once that’s gone I can see an uprating on the cards.

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Alan Oscroft owns shares in Lloyds. The Motley Fool UK has recommended Barclays and 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.