Risk vs Reward
Brexit concerns have weighed on the share prices of these two banks in recent months, and it’s easy to see why investors are haunted by the spectre of departing the EU. If the UK economy slumps after we leave at the end of March, banks will almost certainly suffer. Although it’s difficult to quantify how severe the downturn will be, it is reasonable to say OneSavings and CYBG could have to deal with higher loan loss ratios and a decline in lending.
If this is the case, then why do I think they could double your money? It all comes down to the risk-reward ratio. These two stocks seem so undervalued that even in the worst case scenario, I reckon they will yield a positive return. And, in the best case scenario, they could double.
Take OneSavings for example. Right now, shares in this £918m market-cap are trading at a forward P/E of just 6.5 — a multiple that might be acceptable if the bank was losing money or had a weak balance sheet.
However, with a return on equity of more than 20%, it’s one of the most profitable banks in the UK, and possibly even Europe. Even if the company doesn’t grow for the next five years, in my mind this kind of profitability deserves a multiple of at least 10-12 times earnings.
Investors will be paid to wait for a recovery as OneSavings supports a yield of 3.8%.
City analysts believe the company can produce earnings per share of 57.9p for 2019, a multiple of 12 times earnings on this target gives a possible share price of 694.8p. That’s an upside of 85% from current levels. Add in two years’ worth of dividends (16.6p per share based on current City estimates) and investors could be in line for a total return of 95% over the next few years.
Better than expected
CYBG offers a similar potential return. Shares in this challenger bank bounced earlier in February after it lifted its forecast for margin and lending growth. Meanwhile, management is making good progress integrating Virgin Money.
This is all good news and leads me to believe that the City’s outlook for CYBG is too pessimistic. Analysts have downgraded their growth targets by around a third since October. They now expect the bank to report earnings per share of 23.3p for fiscal 2019 — that’s down from the October target of 31p. Over the next few weeks, as the City digests CYBG’s Q1 results, I reckon this target will be revised substantially higher.
Even without an earnings upgrade, CYBG looks cheap. It’s currently trading at a forward P/E of 7.6 and yields 4.5%. I reckon the company can eventually get to the City’s previous earnings target of 31p and, using this target, with a potential earnings multiple of 12, I arrive at a price of 372p.
After adding in two years of dividends, currently 11p per share, I reckon investors buying today could see a total return of as much as 102% from CYBG over the next few years.
Rupert Hargreaves owns no share 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.