Patience is one of the key attributes of a successful investor. The likes of US master Warren Buffett have been known to wait years for the right company at the right price.
Now, while buying stocks at a fair price will tend to pay off over the long term, we all love to bag a real bargain.
Today, I’m going to tell you the price I believe would put Royal Bank of Scotland (LSE: RBS) (NYSE: RBS.US) in the bargain basement.
Asset valuation
If I had to use just one financial ratio for valuing banks, it would be price-to-tangible net asset value (P/TNAV). If you can buy £1 of assets for less than a quid, you’re sitting pretty — if the assets are accurately valued.
Back at the start of 2012, RBS was trading on a P/TNAV of 0.6. In other words, investors were paying just 60p for every £1 of assets. More recently, RBS’s shares were changing hands at a P/TNAV of about 1. The current market sell-off has seen the shares drop to 345p, bringing the P/TNAV down to 0.92.
Now, as banks have cleaned up their balance sheets since the financial crisis, TNAV has become more reliable. However, there’s still a way to go, and the question is whether RBS’s current 0.92 P/TNAV represents a sufficient discount to put the shares in the bargain basement.
At what price a bargain?
The cheapest bank on a P/TNAV basis is currently Barclays at 0.78. In a recent article, I explained why I think Barclays would be in the bargain basement at a P/TNAV of up to 0.9. What of RBS?
Well, recent newsflow from RBS, particularly, on its ‘bad bank’ assets, has been generally good. Management said at the end of last month that it “now expects to significantly outperform its previous guidance of c£1bn total impairments for FY 2014”. Nevertheless, RBS reiterated that “previously disclosed uncertainties remain, particularly relating to conduct and litigation matters”.
Analysts at Merrill Lynch noted at the time:
“Today’s news is clearly positive, but a word of caution. RBS already trades on 1.0x 2015e tNAV (vs. Barclays (Buy) on 0.8x); it does not appear cheap. Moreover, we still believe that higher restructuring spend, conduct costs and ‘more normal’ impairments may yet deliver a small Attributable Loss in 2015e”.
Some analysts were more bullish, but as I’m looking for a bargain-basement price, I need a margin of safety based on the more negative end of the analysis spectrum.
In this light, and given that RBS remains under government control and pays no dividend, I would find it difficult to rank the Edinburgh-headquartered bank more highly than Barclays. In fact, I’d want a bit of a larger discount to consider RBS in the bargain basement.
So, while I reckon Barclays is bargain value at a P/TNAV of up to 0.9, I’d rate RBS a bargain only at up to about 0.85. As things currently stand, that equates to an RBS share price of no more than 320p. (It’s at 343p at the time of writing.)
