At the time of writing, the RBS (LSE: RBS) share price is dealing at a price-to-book ratio of 0.5.
In theory, this implies that the stock could rise by 100% from current levels because most profitable businesses deserve to trade at or above book value, i.e. the replacement cost of the entire undertaking.
But what are the chances of this happening? Today I’m going to try and discover if the RBS share price can double your money or if it is worth looking elsewhere for capital gains.
RBS’s reported book value is just under £46bn compared to the bank’s current market capitalisation of £24bn. These numbers imply that it would be better to buy the group, break it up and return the capital to shareholders rather than trying to run the business.
This isn’t going to happen any time soon, but I think the example clearly illustrates how undervalued RBS appears to be at this point.
That being said, the reason why it is so difficult to place a value on banks in general is because we don’t really know what is on their balance sheets. Like all other financial institutions, RBS is required to declare any loans forwarded to customers as well as deposits and other assets. But as many bank shareholders found out in 2008, it is impossible to tell precisely where the skeletons are lurking based on the limited figures the firms publish for investors.
With this in mind, it makes sense that the market would place something of an uncertainty discount on bank shares.
From this perspective, RBS’s valuation does not look too out of whack, although I think a discount of 50% to book value is quite high. A discount of between 30% and 20% might be more appropriate. Most of the bank’s peers are currently trading at a price-to-book ratio of around 0.9, implying a discount of approximately 10%.
The bottom line
Considering all of the above, I think it is unlikely that the RBS share price could double your money.
While the bank has made tremendous progress over the past 10 years, rebuilding its balance sheet. There is still a high level of uncertainty around the business, even though profits have recovered to more than £3bn.
But that doesn’t mean shareholders will be left out of pocket. Last year, RBS paid its first dividend since the financial crisis. At the time of writing, analysts are expecting it to distribute a total of 24.4p per share this year, giving a dividend yield of 12.3% on the current price. A dividend of 16p is expected in 2020, offering a yield of 8.1% on the current share price.
So, as an income stock, RBS certainly looks attractive right now, but it’s difficult to say if capital growth is also on the cards.
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.