Successful investors use a disciplined approach to picking stocks, and checklists can be a great way to make sure you’ve covered all the bases.
In this series I’m subjecting companies to scrutiny under five headings: prospects, performance, management, safety and valuation. How does Barclays (LSE: BARC) (NYSE: BCS.US) measure up?
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1. Prospects
Banking is sensitive to economic growth, thriving on high leverage and loose regulation when default risks and market volatility are low. Those factors have all been adverse but offer upside as and when conditions return to normal, provided tail-risk shocks such as a eurozone meltdown do not intervene.
A universal bank, Barclays is most exposed to the UK economy, with its big investment banking business (60% of 2012 PBT) also highly dependent on the US. It is also making a big play on Africa.
New management’s strategy is to invest in areas of competitive advantage, shrink assets and costs, and restore Barclay’s tattered reputation, with 2015 as a target for a transformed bank.
2. Performance
Barclays survived the financial crisis without government support, but only because its bid for ABN AMRO was topped by RBS and it received equity from Qatar in a highly dilutive offering still under investigation by the Serious Fraud Office.
Return on equity (RoE) was in the high 20s until the financial crash. Barclays’ new target is for RoE to exceed the cost of capital (currently 11.5%) by 2015.
Dividends rose progressively before the crash. After rebasing they are now expected to grow progressively, with management targeting a 30% payout ratio.
3. Management
Previously comprising a majority of former investment bankers, Barclays’ board has been changed wholesale since the LIBOR scandal forced the former chairman and CEO out of the door, with the finance director going once a successor is appointed.
The new chairman, former investment banker turned industry regulator and critic Sir David Walker, and CEO, retail banker Antony Jenkins, are stressing reputational values and shareholder returns.
4. Safety
Contagion means that tail risks impact sector-wide. Barclays itself has legacy reputational and litigation risks.
Capital buffers are the best defence. The Prudential Regulatory Authority calculated that Barclays was £3bn short of meeting its 7% common equity tier 1 ratio last year end. Barclays is confident of addressing this without further equity, though a new requirement for a 3% leverage ratio could be more troublesome.
5. Valuation
Barclays is trading at 0.7 times net asset value (0.8 times tangible NAV), i.e. less than the value that theoretically could be achieved by running the bank down. The shares are weighed down by lingering doubts over asset quality and fear of credit, market, economic and litigation risk.
The prospective price-to-earnings ratio of 8 times is the lowest in the sector and well below market average.
Conclusion
Barclays has a strong franchise and clear strategy to exploit it, but financial success is dependent on the strength of the economy. If you are comfortable with tail risk and economically bullish, the shares are cheap.
It’s sensible to balance more speculative investments with safer bets, such as the five companies in this report. They each have dominant market positions, healthy balance sheets and robust cash flows that underpin their reliability and future dividends.
You can download the report by clicking here — it’s free.
> Tony does not own any shares mentioned in this article.
