City analysts currently have an average target price of 259p for Barclays (LSE: BARC) and 628p for Standard Chartered (LSE: STAN). In both cases these target prices are around 50% above current price levels.
Has the City got it wrong, or do Barclays and Standard Chartered have the potential to deliver big profits for investors?
Where do these numbers come from?
Analysts are likely to use a variety of complex financial models to calculate their target prices for banking stocks. These may involve estimates of asset value, future profits and each bank's ability to pay dividends.
For private investors like you and I, the amount of data and educated guesswork involved in these models makes them impractical. On top of that, analysts' forecasts are often wrong anyway!
However, there are simpler methods we can use to estimate whether shares in these banks may be worth more than their current price.
A traditional value-investing technique is to look at the tangible book value of a stock. In theory, this is what it would be worth if the underlying business was liquidated and sold.
Both Barclays and Standard Chartered trade significantly below their net tangible asset values.
Tangible net asset value (NTAV) per share
I've had to estimate the NTAV for Standard Chartered as the bank hasn't yet published a set of accounts after its rights issue, which raised fresh cash and increased the share count. However, it's clear that the current share price is significantly below the bank's book value.
Banks' shares trade below their book value for two reasons. Either the market thinks that the bank's assets might go bad, or investors don't believe the bank can generate satisfactory returns from its assets.
I suspect that Barclays and Standard Chartered trade at a discount to book value for both of these reasons.
Both banks have disappointed income investors in recent years. Weak earnings have meant that Barclays' dividend hasn't grown as fast as was hoped. Standard Chartered's payout was cut last year.
Earnings forecasts for both firms have trended relentlessly lower over the last year. Forecast 2015 earnings per share for Barclays have fallen from 26.4p a year ago to 21.7p today. Forecasts for Standard Chartered's earnings have fallen from $1.56 per share to just $0.38 per share. Even allowing for the dilution caused by last year's rights issue, that's a big drop.
Shares in Barclays have fallen by 37% over the last year, while Standard Chartered has fallen 55%. As a result, both banks have undemanding P/E ratings and fairly average dividend yields:
2016 forecast P/E
2016 forecast yield
If I'm honest, Standard Chartered's valuation looks about right to me, given last year's dividend cut and the uncertain outlook for earnings.
Barclays does seem cheap, but reflects investor doubts about the speed and success of the bank's long-running turnaround plan. New chief executive Jes Staley hasn't yet convinced the market of his vision for the company.
In the short term, I think the shares of both banks are probably priced about right. On a longer view, I expect shareholder returns to improve at both. Share prices should eventually rise too.
For this reason, I rate Barclays and Standard Chartered as long-term buys at current prices.
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Roland Head owns shares of Barclays and Standard Chartered. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.