Famed investor Jim Slater once said that when buying a turnaround stock, “it is absolutely essential” that forecasts for the year ahead show rising profits. Investors tempted by the Barclays (LSE: BARC) share price can tick that box — profits are expected to bounce back next year.
However, anyone who has followed the big bank stocks for a while will be aware of the risk that this could be yet another false dawn. Will it be different this time? I think it could be.
Better than expected
One reason for my optimism is that Barclays’ third-quarter results on Friday were better than expected. New charges for bad debt fell to £608m, compared to £1,623m during the second quarter. Although these numbers are still far higher than at the same point last year, this fall is encouraging as it suggests the economy could be stabilising.
Another piece of good news from Friday’s figures came from Barclays’ investment banking division. Critics of CEO Jes Staley have said that he should wind down this operation. Mr Staley — a former investment banker — has resisted this pressure. This year’s results suggest he might be taking the right path.
Profits from Barclays’ corporate and investment banking operations have risen by 24% to £9.4bn during the first nine months of 2020. That’s helped to offset a 21% reduction in profits from credit cards business and a 12% drop in profits from UK high street banking.
Mr Staley’s strategy of diversification appears to be paying off. Weaker profits in some areas have been offset by gains elsewhere. That’s a good result, in my view, although I’m not sure if this strength will continue into 2021.
Bargain buy or value trap?
Barclays’ share price rose by 7% on Friday as the market digested these results. Despite this, the stock still looks very cheap on most measures.
For example, at 112p, the shares trade at a 60% discount to the bank’s tangible net asset value of 275p per share.
Using profits as a guide, Barclays stock is priced at just eight times 2021 forecast earnings.
The shares could also offer a decent dividend yield — consensus forecasts suggest a payout of 4.6p in 2021, which would give the stock a yield of 4.1%.
All these numbers look attractive to me. I can also see some other positive signs. Barclays costs fell to 60% of the bank’s income during the first nine months of this year. That compares to a figure of 72% during the same period last year.
On the face of it, I think Barclays’ shares offer good value at current levels. I only have one concern.
Barclays shares: I might buy
The big concern with all the major UK banks is that they’re just not very profitable. Barclays’ return on tangible equity was just 3.6% during the first nine months of 2020. That compares to a figure of 5.1% last year, which isn’t very exciting either.
Banks that generate low returns tend to trade on modest valuations. With interest rates low and the UK economy likely to face a recession, I’m not sure how quickly things will improve.
Despite this, I do think Barclays shares are cheap enough to buy. Over time, I’d expect positive returns from this level. However, I think there are probably more exciting choices elsewhere.
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Roland Head 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.