Years of poor performance and a toxic reputation mean that many investors continue to ignore the banking sector. But the reality is that UK banks are much stronger and healthier than they were a few years ago.
In this article I'm going to look at two of my preferred picks in this sector.
FTSE 250 specialist bank Investec (LSE: INVP) offers private banking to wealthy individuals and investment banking services to businesses. The group's two largest markets are the UK and South Africa.
Investec shares have risen by 42% over the last five years, almost double the 22% gain delivered by the FTSE 100 over the same period. But despite this gain, the shares don't look expensive. They currently trade on a forecast P/E of 10.5, with a prospective dividend yield of 4.5%.
Friday's half-year trading update was also encouraging. Third party assets under management rose by 6.1% to £160bn during the six months to 30 September, while customer deposits rose by 1.3% to £39.5bn.
Interestingly, the group expects 75% of its operating income to have been recurring, up from 72% during the same period last year. I'm always attracted to businesses with high levels of recurring income, as it's often 'sticky' and more profitable than one-off income.
Management expects half-year operating profit to be "comfortably ahead" of the same period last year. Use of "comfortably" suggests to me that broker forecasts for earnings per share growth of 12% this year are about right.
Although Investec's management remains cautious about the economic outlook in the UK and South Africa, I think the bank's shares are reasonably valued at the moment, and could be an attractive income buy.
The ultimate turnaround?
In recent years, many investors have treated Royal Bank of Scotland Group (LSE: RBS) as a lost cause. This may have been true for a while, but I think that the situation has changed significantly.
A huge amount of progress has been made in strengthening the bank's balance sheet and disposing of bad assets. RBS is expected to move back into the black this year for the first time since 2009. Analysts are expecting the bank to report a profit of £2.8bn, giving adjusted earnings of 23.8p per share.
If that's correct, it puts the stock on a very reasonable P/E of 10.7. Value investors may want to consider that the shares also trade at a discount of about 16% to their net tangible asset value of 300p per share. If profitability continues to improve, I'd expect this discount to close.
Of course, RBS still has two big problems from an investment point of view.
The first is that the government still owns nearly 71% of its stock. But this number is falling. I suspect further share sales will be made in 2018, not least because selling its stake in RBS could provide the Treasury with a £21bn windfall.
The second problem is that the bank has not yet restarted dividend payments. But this is also expected to change in 2018. Broker consensus is for a dividend of 8.8p per share next year, giving the shares a potential yield of 3.5%.
In my view, RBS is one of the more attractive banking stocks in the FTSE 100 at the moment.
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Roland Head owns shares of Royal Bank of Scotland Group. 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.