If it looks cheap, smells cheap, and acts cheap, it probably is cheap, and that’s the case with Royal Bank of Scotland Group (LSE: RBS) right now. Even as earnings recover and the firm restarts dividend payments, the share price continues to plunge, and I reckon there is a good chance RBS is cheap for a reason – and could get cheaper from where it is now, perhaps much cheaper.
Today’s third-quarter interim management statement hasn’t helped. The stock was down more than 5% in early trading this morning, continuing a slide since May of around 25%. Yet the figures are good. Operating profit is just over 10% higher than the equivalent period last year at £961m, adding to a total of £2,787m for the year so far, which is a far cry from the dark days of 2013 when the bank posted an operating loss for the year of £8,849m.
There may be trouble ahead
I reckon the market was spooked this morning because RBS has applied “an additional” £100 million impairment charge “reflecting the more uncertain economic outlook” and a £60 million impairment charge in its Irish business because of “ongoing sales from our loan book to further reduce the level of non-performing loans.” The bank is preparing for trouble ahead and, right on cue, the share price reacted in the way out-and-out cyclical shares are ‘supposed’ to behave – it fell.
I watched a discussion on Bloomberg TV this week where several ‘experts’ were discussing bank stocks in general. They argued that because banks have been building up their capital reserves they are better prepared than ever to withstand the next cyclical shock in the economy, or the next down-leg if you will. One even declared that banks are the new defensives because they are so safe and reliable for investors now. It was in essence that old stock-market chestnut that has been debunked many times over the years: ‘this time it’s different’. My response to that is, “Tosh! It’s never different.”
More of the same
If the economy dives, taking the profits of RBS with it, I reckon the shares will plunge too, and that reborn dividend that’s been so long in gestation will likely wither as well. We’ve seen today how responsive the shares are to even the slightest whiff of negative news in the outlook. It’s a huge risk for those participating in bank stocks right now, and the chance of a catastrophic plunge is always heightened when the banks are posting big profits, as now with RBS. What else can mark the top of a cycle but big profits? And after the top, comes the plunge to the bottom, otherwise it wouldn’t be a cycle and banks wouldn’t be known as cyclical stocks.
RBS said in today’s report that it retains the outlook guidance it provided with the 2017 accounts. Back then the firm said it is dealing with a range of “significant” risks and uncertainties in the external economic, political and regulatory environment and managing conduct-related investigations and litigation. The directors said then that “substantial additional charges and costs may be recognised in the coming quarters,” and we’ve seen some of that today. They’ve clearly got their eyes on the downside too, and said they “remain mindful of potential downside risks, particularly from single-name and sector-driven events.” I’m avoiding shares in RBS.
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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.