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Here’s what I’d do about the RBS share price and its 11% dividend yield

Rupert Hargreaves
Coworkers standing near a wall

According to City analyst forecasts, at the time of writing, investors will receive dividends worth 11% of the RBS (LSE: RBS) share price for 2019. If the company hits this target, the stock will support one of the highest dividend yields in the FTSE 100.

This is a drastic turnaround from where the bank was around 10 years ago. RBS was brought to its knees by the financial crisis, and it has taken the group nearly a decade to recover.

The company was forced to sell hundreds of billions of pounds of assets as part of its recovery and, today, it’s a much smaller business than it was before the crisis. However, a smaller, leaner RBS is now much easier to understand, and I think it has much brighter long-term prospects.

A streamlined bank

RBS used to be one of the world’s largest investment banks but, as part of its recovery, it’s slimmed down its trading division to focus on more traditional banking activities, such as mortgages and credit cards.

These businesses are less profitable but more predictable. For example, the remaining investment banking business, which operates under the NatWest Markets brand, reported an operating loss of £193m in the third quarter. The loss, coupled with an additional £900m charge from the PPI scandal, pushed RBS to a pre-tax loss of £8m for the quarter, compared with a profit of £961m in the same period last year.

Nonetheless, looking forward, it seems as if the outlook for the bank is bright. Now the deadline for making historic PPI claims has passed, RBS should be able to reveal its full post-crisis potential. City analysts had been expecting the lender to report a total net profit of £3.2bn this year, but it now looks as if RBS won’t be able to meet this target. Still, 2020’s current goal of £3.1bn in net income appears possible at this stage.

Income champion

With profits booming, I see no reason why RBS cannot maintain its dividend crown. With profits growing, I think management will return the majority of the bank’s income to shareholders, rather than using these funds to try and turbocharge growth. That was the mistake RBS made in the years before the financial crisis, and we all know how that worked out. I reckon the lender’s new CEO, Alison Rose, will be keen not to repeat the same mistakes.

As well as the market-beating dividend yield, shares in the bank also trade at a low valuation of just 8.6 times forward earnings, and a price to tangible book value of 0.7.

While there are risks to growth on the horizon, such as Brexit and the US-China trade war, I think this low valuation more than compensates investors for the potential uncertainty. And with that being the case, I believe the RBS share price could be an attractive income investment at current levels.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2019