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Why I’d buy the undervalued Barclays share price and this 6% dividend stock

Is small beautiful or does it pay to think big? Most investors in banking stocks believe that size matters, but this isn’t always the case.

Think small

It isn’t hard to see why most of us focus on big high street banks such as Barclays (LSE: BARC). This is a FTSE 100 giant with a market cap of £26bn that generated total income of more than £21bn last year and posted a profit before tax of £3.49bn. Yet you shouldn’t let that blind you to opportunities elsewhere.

Many investors won’t have given Secure Trust Bank (LSE: STB) a second glance, yet this is a really tempting dividend stock with a forecast yield of 6.7%, underpinned by substantial cover of 2.1. Its share price is up almost 8% today after it published its audited full-year results, which showed a healthy 38.8% increase in group profit before tax to £34.7m in the year to 31 December. 

Going up

Today’s numbers all look good, with operating income up 17.1% to £151.6m, basic earnings per share up 42.2% to 153.2p, and adjusted return on average equity of 13.1%, up from 8.9% in 2017. Today it said its “higher quality book has significantly reduced cost of risk” and it has a healthy common equity tier 1 ratio of 13.8%. This has fallen from last year’s 16.5% but should still support strong growth in the bank’s loan portfolios.

Secure Trust Bank can trace its history back to 1952, although it only listed on the London Stock Exchange in 2016 where it has a current market cap of £254m. Its primary focus is savings and mortgages in the personal market, and business banking.

City analysts anticipate healthy EPS growth of 15% this year and 16% in 2020, yet it trades at an embarrassingly cheap valuation of just 7.4 times earnings. That is partly due to a 21% share price slide over the past year, but the recovery may now have started. By 2020 yield is forecast to hit 7%. Well worth checking out.

Think big too

Barclays has also had a rough year, its share price falling 25%. It has been hit by Brexit uncertainty, stock market volatility and global recession fears, which could hit the banking sector by triggering a sharp increase in customer bad debts.

This might be a bigger concern if Barclays stock was trading at a toppy valuation, but it is yours for just 7.1 times earnings. Its price-to-book value stands at just 0.4, well below the 1 that is seen as fair value. Even better, EPS are forecast to rise 136% this year to 22.15p, giving cover of 2.9, with the dividend expected to be just 7.51p a share.

Maybe buy both

The regulatory authorities have also worked hard to boost banking sector security and Barclays now has a Tier 1 ratio of 17%, for added peace of mind.

Currently, Barclays is on a prospective yield of 4.8%, which is forecast to hit 5.5% in 2020. That’s not quite as generous as Secure Trust Bank, but still tempting as further dividend growth is expected. These two banks are both available at dirt-cheap valuations and sky-high yields. Sometimes big and small can be beautiful at the same time.

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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays. 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.