Last week’s update on trading from battered challenger bank Metro Bank (LSE: MTRO) saw the shares leap in price. Does this suggest you could double your money by buying the stock now?
Reasons to be optimistic
One reason to think the share price could bounce back to form over time is that Metro remains financially strong. The bank has Common Equity Tier 1 Capital of almost £1.5bn at the end of September, representing 16.2% of risk-weighted assets — far more than the minimum required by regulators of 10.6%.
Put simply, this means Metro should have no issue dealing with any financial stress and remaining solvent.
Recent board changes could also be a reason to be hopeful. The fact its founder and chairman Vernon Hill will now leave earlier than expected (with Sir Michael Snyder taking his place) is indicative of a company wanting to turn things around as soon as possible.
A final reason is simply that expectations are already as low as they can get, evidenced by last week’s share price action. If the bank is able to convince the market that a new business strategy — which looks likely to be revealed next year — will be enough to stop the rot, the shares could fly.
The arguments against Metro Bank doubling your money, however, are compelling. First, the business has not yet returned to normal. Indeed, things could get worse before they get better.
It may be attracting more customers (106,000 over Q3) but this is being achieved at a cost. Offering higher rates of interest in an effort to grab market share from the established players has a knock-on effect on profits.
Whether reducing operating expenses is sufficient to cope with this remains to be seen, especially as the bank will be making high interest payments on its bonds going forward. Total deposits are also rising at a slower pace compared to the same period last year and there’s practically no lending growth.
Secondly, Metro Bank continues to attract short sellers — those who bet on a company’s share price falling. For perspective, only Thomas Cook and oil services firm Wood Group are higher when it comes to ranking the most hated shares on the London Stock Exchange.
Shorters can be get things spectacularly wrong sometimes (which can lead to share prices soaring as they attempt to close their positions), but I’d be wary, especially as the company is still to face the music from regulators over an accounting error.
A final argument is simply that Metro has become a plaything for both bearish and bullish traders. That’s a recipe for volatility — something many investors struggle to deal with. Will you be able to remain composed if, as I suspect it will, Metro Bank’s share price jumps around over the coming weeks and months?
While it’s certainly feasible you could double your money in Metro Bank, it’s quite possible you could lose a lot as well. That’s streets away from the Foolish philosophy of purchasing quality stocks at fair prices and holding for the long term.
If you simply must buy, I’d recommend keeping any position small and only using money you can afford to lose. Save the majority of your capital for strong, dependable businesses that don’t require constant vigilance.
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Paul Summers 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.