Three reasons why investors think Barclays shares are cheap (and may deserve to be cheap)

“There is much to like about Barclays’ 2022 results – margins on the loan book are up, the dividend per share is up to its highest level since 2008 and overall profits would have set a new high for this century if the bank did not have to pay out more than £2 billion in regulatory fines and costs for litigation and compensation,” says AJ Bell investment director Russ Mould.

“But there lies the problem, because there always seems to be an ‘if:’ if there hadn’t been another fine for poor conduct; if the investment bank had done better; and if sour loan write-downs had not gone up the results would have looked better.

“All of those ifs, buts and maybes help to explain why the shares are down today and why they trade at less than two-thirds of the stated tangible book value per share of 295p. The shares are undeniably cheap, but investors clearly think they deserve to be cheap for three reasons, despite those lofty profits and cash returns to shareholders.

Source: Company accounts, Marketscreener, analysts’ consensus forecasts, Refinitiv data

“The first is the bank’s propensity to find regulatory trouble. Over the past ten years, conduct and litigation have cost the bank £18 billion. Aggregate pre-tax income over the same decade has been £45 billion (and dividend payments £8 billion), which may be enough to persuade shareholders to ponder what might have been.

Source: Company accounts

“The second is the risk of more bad loans. The economic cycle could yet turn down and expose Barclays to a fresh round of write-downs and asset impairments. The £1.2 billion bill here in 2022 was pretty muted by historic standards and was the second-lowest figure in a decade, behind only 2021 when Barclays wrote-back a chunk of the provisions it took in the pandemic-stricken year of 2020.

Source: Company accounts

“But the trend does look to be one of increasing loan losses and if the economy softens it seems logical to expect that trend to become even more pronounced.

Source: Company accounts

“The third is the investment bank and its volatile, unpredictable performance. Sherborne Investors and Edward Bramson may no longer be shareholders, having failed to persuade Barclays to spin-off the capital hungry investment bank, but those who championed the retention of the unit cannot declare victory even now. Bramson lost money on his stake, having bought around 200p in March 2018 and sold for an average of 186p in May 2021, but Barclays’ shares have made no progress since, unlike the FTSE 100, which has risen by 12%.

“A dearth of new stock market listings and merger and acquisition deals took its toll, as did rising interest rates as clients raised less debt and therefore paid fewer fees. Pre-tax income at the corporate and investment bank slid to £560 million, the lowest figure since Q4 2019, as the bubbly stock and bond markets which did so much to boost banking fees in 2020 and 2021 lost some air in 2022. Mr Bramson exited stage left muttering about how it was getting late in the investment banking cycle, and he may yet have the last laugh, even if he lost the argument and some of his investment, especially if we get a real bear market at any stage – profits from Barclays’ corporate and investment bank peaked just as he abandoned his campaign.

Source: Company accounts

“Barclays UK made an average return on £10 billion of tangible equity of 18.7% in 2022. The corporate and investment bank made 10.2% on £32.8 billion of net tangible assets and the credit cards and payment business made 10.0% on £4.8 billion. A big wobble in financial markets would not help those comparisons and we may need to go through a full economic and market cycle to see whether Barclays was right to send Mr Bramson packing, or whether the board will have to repent at leisure.

“And the board may well be frustrated by such a debate, given how Barclays’ profits are humming along, the bank continues to increase its dividend and also adds to its share buyback programme.

Source: Company accounts

“None of those argue that the bank’s lowly valuation – a big discount to historic net asset value, a forward price/earnings ratio of barely five times and a prospective dividend yield of more than 5% – is appropriate. But investors are clearly afraid of tougher times ahead for the £160 billion mortgage book, £38 billion credit card loan book, £54 billion in corporate lending and £17 billion exposure to commercial real estate.

“Barclays itself expects its loan loss ratio to broadly double in 2023 to 50 to 60 basis points (0.5% to 0.6%) from 30 (0.30%) in 2022.

Source: Company accounts, Barclays investor relations website, analysts' consensus forecasts. *2023E loan loss ration based on mid-point of management guidance

“However, analysts had already pencilled in £2.7 billion of credit impairments for 2023, going into the 2022 numbers, so this should not have been a surprise. Bulls of Barclays’ stock will argue that the lowly valuation means a lot of bad news is already in the price, especially as consensus estimates are looking for only a modest increase in pre-tax profit in 2023, despite the (assumed) absence of further major regulatory fines and the bank easily passes regulator requirements on capital ratios.

“Barclays is currently making double-digit returns on tangible equity across all three business units and if it can keep that up, the shares will look undervalued – but there is that word ‘if’ again.”

These articles are for information purposes only and are not a personal recommendation or advice.