Stock In Focus: Why Screen Watchers Should Step Carefully With Barclays

18th Oct '17 by Roland Head

8 comments 6695 reads

Taking a break from the stock market can be a useful reminder that for much of the time, successful investing is about patience. I’ve just taken a couple of weeks off, during which I’ve paid very little attention to the SIF portfolio or my personal shareholdings.

As someone who follows the market quite closely, this neglect requires some adjustment. But as usual, reassuringly little has happened in my absence, despite a slew of positive updates from portfolio stocks Air Partner, Fulcrum Utility Services, Sirius Real Estate and Flowtech Fluidpower.

Happily, the portfolio has stayed ahead of the wider market while I’ve been away. SIF has gained 6.4% since my last column was published, versus a market gain of 3.3%:

SIF performance so far in 2017.

Of course, these are short-term movements against the backdrop of a bull market. A correction could soon change the picture.

The reality is that most worthwhile investment gains are measured in months and years, not weeks. So this week I’m going to take a look at a stock I hold in my personal portfolio, which made a surprise appearance in the SIF screen just before I went on holiday.

A value play gone bad?

Banking group Barclays has become a serious test of my patience. It’s been a member of my value/turnaround portfolio since 2014, but has consistently failed to deliver.

Despite what I believe is a genuine improvement in underlying performance, the market isn’t buying into broker forecasts for an improving outlook:

One reason for this may be the risk posed by the Serious Fraud Office’s decision to charge the bank in relation to its 2008 refinancing.

Barclays’ share price has fallen by 14% so far in 2017, underperforming the FTSE 100 by about 20%. My losses are relatively modest, but the opportunity cost of tying up cash in this stock is growing. In July, Stockopedia reclassified this stock from a Turnaround to a Value Trap. That’s definitely a demotion and could be a concern for shareholders.

Does the appearance of the battered bank in my SIF screen results suggests that a turnaround may finally be in sight? Or does the bank’s uncompetitive performance mean that we’re still at…

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The Third Man

18th Oct '17

Given that Barclays Stockbrokers have allegedly already lost 30,000 investors to HL alone following the fiasco of Smart Investor and the bad publicity it is attracting I cannot see much positive for Barclays shareholders in the near future.

Roland Head

@TheThirdMan

I'm not sure whether the retail stockbroking business makes a very big contribution to Barclays (LON:BARC) profits, but I take your point about damage to the bank's high street brand.

Regards,

Roland

aflash

19th Oct '17

My six ratios for banks are:

1. Price to Tangible Book Value
2. Net Interest Margin
3. Cost to Income Ratio
4. Return on Equity (ROE)
5. Return on Assets (ROA)
6. Non-Performing Loans/Gross Loans

No 1. P/B & P/TB is provided by Stockopedia but you point out it is of dubious value.
BARC is the cheapest among the majors.

No 2. Net Interest margin = interest rate spread - the difference between interest received and interest paid;
What's best is to look at the different net interest margins between banks with similar businesses.
Those with higher margins tend to be better managed.
Not sure Stockopedia’s ‘Operating Margin’ is the same.

Help please.

No 3. the 'Cost efficiency ratio'= Cost to income - compares non-interest expense to total income.
Most of a bank's expenses are, or should be, the cost of funding the loans they make. This either consists of interest rates paid to depositors, or the cost of wholesale funding in the money market. Equally important is to keep other non-interest related expenses in check. This is what the ratio measures.
The lower the number, the better it is. The expectation should be that it is less than 60%, and perhaps even less than 50%.
BARC to June 2016 = 72%

HSBA to Dec 2016 = 83%

Positive (one hopes) ‘Jaws’ measure % growth rate income versus % growth rate of expenses

No 4. Return on Equity - calculated as any other company, with post-tax profits measured against average shareholders' equity. Ideally in this case, the number should be greater than 15% for the bank to be creating some value for shareholders.
BARC 2,47

RBS negative

STAN almost zero

HSBA below 1

LLOY 4,34

CBG 16

BGEO 20,9

No 5. Return on Assets: is a trickier number. A bank's assets are the loans it makes and therefore its assets will dwarf shareholders' equity and hence the return on average assets, though positive, will more than likely be a low single-figure percentage.
Stockopedia calculates ROCE =Earnings/Total Assets minus Total Current Liabilities.

Help please.

BARC and STAN are trading below cash presumably as they reorganise and slim down their balance sheet.

No 6. 'non-performing' loans as a percentage of total loans. The number should be less than 1%.

A lot more could be said but let us see if this draws any replies.

20th Oct '17

Hi aflash,

I use most of these metrics too. Although as a general rule, I think it's worthwhile looking at the actual accounts for banking stocks. For example, Barclays (LON:BARC) (and the other big banks) provides net tangible asset value per share in its accounts, plus various versions of ROE and of course net interest margin.

I'm not an expert on bank accounts, but here are my comments, for what they're worth:

- Net interest margin isn't the same as operating margin, I'm not sure the Stockopedia operating margin figure is all that relevant for banks.

- Similarly with RoA - I may be wrong, but I'm not sure this is especially meaningful for banks.

- For profitability, I tend to focus on RoE and net interest margin, along with the cost: income ratio.

But P/TB can also be a useful measure of the expected profitability/quality of a bank's assets -- if the market doesn't expect the assets to deliver a reasonable return, the stock is likely to be valued at a discount to NAV.

Hope this is of some help.

Regards,

Roland

21st Oct '17

OK for the ratios. I take your point of going to the banks' published accounts.

The 'capital adequacy' ratios do not need discussion, the media keep us informed.

Then comes the cyclical conundrum.

Some one else said (Peter Temple I think):

As we move through a cycle big banks tend to suffer from gradual P/E-compression in anticipation of the next peak-earnings event. That leads to valuation indicators working back-to-front, making banks seem like good value at precisely the wrong time in the macro-cycle. Buying a bank when the P/E rating is low and the dividend yield high can be disastrous because such conditions can presage the next cyclical plunge.

The time to invest in banks is when they have been sufficiently chastened by the aftermath of the latest disaster to proceed (or be forced to proceed) cautiously for a while.

So where are we in the cycle?

Interest rate rises are coming which helps banks' profits and the Regulators used the Great Financial Crisis to improve their solvency.

As we move towards the next recession it seems to me the time to buy High Quality large cap, Low Beta, Dividend yield all of which includes the banks.

I sold my BARC (Barclays) when they decided to sell the Africa division. It is up from the September Lo but still in a down trend. However I have an alert set for 177p, the 61,8% retracement from the February Hi.

I sold my STAN.

Both these banks are still in a mess. However the above arguments apply.

23rd Oct '17

The point about cyclical P/E ratios is similar to that which applies to housebuilders. However, while housebuilders are reporting record profit margins, banks' profitability (e.g. return on equity) is still very low indeed.

My belief is that further improvement in profitability is likely at some point. Rising interest rates is the most obvious example, but an end to misconduct costs could also have an impact. This could drive a re-rating of the stocks up to their book value, or perhaps even a premium to book value.

But I could be wrong, or at least my timing may be badly out...

Regards,

Roland

LongbeardRanger

Roland,

Good article, you highlight a lot of the issues with using screens to assess banks. (Some of the same difficulties crop up with insurers - and, in fact, any company that isn't a normal trading company.)

Personally, I feel that the best measure for a retail bank is price to deposits. It's a bank's deposit base (sticky, low cost or free funding) that allows it to earn profits over time, and deposits are also much more stable over time than book value which, as you observe, can get distorted quite easily.

For what it's worth, Barclays was pretty cheap on this measure last time I looked. Its market cap was about 10% of its deposit base. (Other UK banks were Lloyds 11.75%, RBS 7.8%, and TSB was taken private at the frankly absurd price of 5.8%!)

These figures are quite low. I wouldn't be at all surprised if, some time over the next five years, the banks trade at price/deposit ratios of double what they are now.

Now, that said, I'm not invested in any of the major UK banks, because it's not just a question of rerating- it's also a question of the change in intrinsic value (i.e. cheap deposits) over time and I'm not comfortable on that for any of the big banks. They also fail my safety tests as they all have loan:deposit ratios of over 100%. It's a shame as I do see Lloyd's, in particular, as quite attractive.

Now, I do hold Metro bank (market cap/deposits of c30%...!) but that is because I expect Metro to build its deposit base significantly over the next 10 years. It's quite a different investment proposition than the "cheap " big banks, so I won't go into more detail here, though.

Tks Roland and LongBeard for keeping the discussion going. It is unusual for Stockopedia to talk banks.

There is a 'familiarity' factor with the big ones, as many found their cost during the Grt Financial Crisis.

I held the Challenger banks until Brexit, the Georgian banks, BGEO and TBCG, until they got ahead of themselves but all of them are much better 'businesses' than the big well know banks. 'Better' until everyone gets scared when large cap banks become a safe haven.

You are both suggesting they are undervalued now.

Recently, reluctantly I took some profits on HSBA (HSBC holdings). It benefits from high visibility but the numbers appear poor. I bought, equally reluctantly in Jan and Feb 2016.

BNC (Santander) & LLOY (Lloyds) I hold plus all the Canadian banks via funds.

I follow them all. Brexit complicates matters for the UK based ones. If it is not the danger of a UK recession, it is the cost of investing in clearing operations in Frankfurt and Paris.

Stock in Focus: Why screen watchers should step carefully with Barclays

A value play gone bad?

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Roland Head

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