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Is Banco Santander SA an income buy after profits rise 4%?

Shares of Banco Santander (LSE: BNC) climbed nearly 5% when markets opened this morning, after the Spanish bank said that its full-year net profit rose by 4% to €6,204m in 2016. Earnings per share rose by 1% to €0.41, while the bank’s cash dividend rose by 8% to €0.17 per share.

Santander shares have risen by 55% over the last 12 months, and today’s full-year figures suggest that the outlook is continuing to improve. Customer numbers rose by 1.4m to 15.2m last year, while lending increased by 2% and customer deposits climbed 5%.

The underlying quality of Santander’s assets also appears to be improving. The bank’s Common Equity Tier 1 (CET1) ratio rose by 0.5% to 10.55% last year. The rate of non-performing loans fell to 3.93%, down from 4.36% one year ago.

Is Santander still a buy?

Unlike some of the large UK banks, Santander shares don’t trade at a discount to their tangible book value. With the shares at 460p, the stock has a price/tangible book ratio of 1.3. For deep value investors, it’s probably not of interest.

However, if you’re looking for businesses with rising profits, an affordable valuation and an attractive dividend yield, I believe it could have something to offer.

The latest forecasts suggest that the bank’s earnings per share will rise by 6% to €0.45 in 2017. The dividend is expected to rise to €0.21 per share. These figures give the stock a 2017 forecast P/E of 12 and a prospective yield of 3.9%.

In my view, Santander could be an attractive income buy at these levels.

A more exciting alternative?

Santander is one of the world’s largest banks, with a market cap of £65bn. Its share price is unlikely to rise by 55% again this year.

However, one bank whose shares could rise by 50% is challenger firm OneSavings Bank (LSE: OSB). This small outfit has a market cap of just £785m, but has fast-growing earnings and an undemanding valuation.

For example, its underlying pre-tax profit rose by 36% to £64.6m during the first half of last year. The group’s loan book grew by 10%, while its CET1 ratio rose from 11.6% to 13.3%.

Its small size helps keep costs low. The bank reported a cost-to-income ratio of 27% in its most recent results. By way of comparison, the equivalent figure for Santander is 48%. Most big UK banks are much higher still.

One risk is that the small size of challenger banks such as OneSavings will end up limiting their ability to expand and compete against the established players. So far there’s no sign of this, but it’s something to watch.

In the meantime, it looks quite cheap to me. The bank’s earnings per share are expected to rise by 13% to 39.7p this year, putting the stock on a forecast P/E of just 8.1. The dividend is expected to rise by 15% to 10p per share, giving a prospective yield of 3.1%.

I’m tempted to take a closer look, and would be happy to buy at current levels.

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Roland Head 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.