How Long Should You Wait For Barclays PLC And Standard Chartered PLC To Come Good?

Should value investors keep the faith with Barclays PLC (LON:BARC) and Standard Chartered PLC (LON:STAN), or has the picture changed?

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Are UK banks Barclays (LSE: BARC) and Standard Chartered (LSE: STAN) value plays or value traps?

So far, we’ve seen several false dawns. Yet there has been very little hard evidence that the banks have turned a corner and will be able to deliver decent returns for investors. All that’s happened over the last year is that both banks have cut their dividends and delivered disappointing profits. Is it time for value investors to give up and move on?

Don’t make this common error

One of the hardest things about value investing is that it requires considerable patience. A traditional value investor won’t sell a poorly-performing stock unless the underlying investment story has changed. The need to be patient and hold onto unpopular stocks is one of the reasons why so few investors manage to stick to a value strategy. It can get uncomfortable.

However, patience isn’t the same as sticking your head in the sand. We do need to take a critical look at Barclays and Standard Chartered and ask if their performance is likely to improve.

Here’s the bad news

Both Barclays and Standard Chartered trade at a discount of about 50% to their book value. This is a traditional value indicator, but over the last few years, it hasn’t worked very well for UK banks.

The problem is that the market isn’t convinced about the quality of banks’ assets. They don’t seem to generate much in the way of profit. Until this changes, these shares are unlikely to trade anywhere near to their book value.

Dividend yields are another value indicator that’s failed to deliver. A year ago, Barclays and Standard Chartered had quite attractive dividend yields. These have now fallen because both banks have cut their dividend payouts. This has triggered further falls in both banks’ share prices.

The reality is that neither bank has been able to generate a recovery in earnings. Without this, the shares are unlikely to build the kind of momentum required for a proper re-rating.

Why I’m still holding

There could be some good news. Both Barclays and Standard Chartered are expected to return to profit this year. Barclays’ results are expected to be especially good. Current forecasts suggest the bank will report a net profit of £2.9bn for 2016. The last time profits were at this level was 2011.

Barclays shares currently trade on just 8.2 times 2016 forecast earnings. This low valuation reflects the market’s caution about whether this forecast is achievable. Caution could be wise. Just six months ago, the same City analysts forecast that Barclays would make a profit of £4.6bn in 2016. That’s 58% more than the current forecast!

It’s a similar story with Standard Chartered. Profit expectations for 2016 have fallen from $3.2bn in September to just $500m today. These changing forecasts are a classic example of why value investors tend to rely on historic performance and balance sheet valuations. Earnings forecasts can change daily and may still be wrong.

My view is that it isn’t normal for a FTSE 100 firm to trade at a 50% discount to book value. I believe that either the shares will rise, or each bank’s book value will fall.

I suspect that a gradual recovery in share price is more likely, so I’m holding onto my shares.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head owns shares of Barclays and Standard Chartered. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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