Today, I'm looking at two companies that are currently unpopular among most investors. Neither stock has performed particularly well in recent years and they both face external challenges, which could keep their share prices pegged back in the near term. However, they also offer strong capital gains prospects, which makes them sound buys at the moment.
The best income stock around?
While the FTSE 100 yields an impressive 3.7%, Lloyds (LSE: LLOY) has a yield of 5.3%. Furthermore, its dividends are due to rise by 19.4% in 2017, which puts it on a forward yield of 6.4%. Even better, this doesn't put Lloyds's financial position under pressure, since its shareholder payouts are due to be covered 1.8 times by profit next year. This should provide Lloyds with ample capital to reinvest in order to improve its financial standing and future growth prospects.
While the government still owns a slice of Lloyds, the reality is that the part-nationalised bank is back to full health and not in need of government help. Its asset disposal programme made a major impact on its balance sheet strength as it focused on the parts of the business that offered the best risk/reward ratio. As a result, Lloyds is now leaner, more profitable and has better finances than many of its UK-listed banking peers.
This relatively strong financial situation should allow Lloyds to overcome the challenges it faces from Brexit. While the UK economy has thus far performed well after the EU referendum, the housing market, business confidence and consumer spending could come under pressure and cause Lloyds' performance to decline. Therefore, its wide margin of safety could prove to be an ally for investors, with a price-to-earnings (P/E) ratio of 8.2 offering considerable appeal.
A bargain buy?
Although RBS(LSE: RBS) lacks income appeal, it provides significant capital growth potential. For example, it trades on a price-to-book (P/B) ratio of 0.44. This indicates that the share price could double and still offer good value for money, such is the margin of safety on offer.
Clearly, the outlook for the part-nationalised bank is challenging. RBS hasn't returned to full health following the credit crunch, with asset writedowns and losses continuing to be a feature of the bank's operations. Over the next two years RBS is expected to remain in the red and this could obviously hold back investor sentiment. With Brexit likely to increase uncertainty for the UK economy, RBS could be hit harder than many of its sector peers in 2017.
However, with a sound strategy that's set to successfully turn the bank around over the long run, RBS could be a surprise performer. Its share price could benefit from the gradual improvement in its efficiency, with investors seemingly pricing-in a period of lacklustre performance for the bank. Therefore, RBS offers real turnaround potential and could easily outperform its sector and the wider index in the long run.
But will Lloyds or RBS make you a millionaire?
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Peter Stephens owns shares of Lloyds Banking Group and Royal Bank of Scotland Group. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.