A quick glance at the RBS (LSE: RBS) share price will tell you the stock is cheap. Indeed, at the time of writing, my research tells me shares in this bank are changing hands at a price to tangible book value of just 0.7 and a forward P/E of 7.7. Based on analyst forecasts, the stock is also offering a forward dividend yield of 6.6%.
However, while these metrics might look attractive, this isn’t the first time the RBS share price has appeared undervalued. Indeed, for the past five years, the stock has looked attractive from various perspectives even though it has been in the midst of a brutal restructuring programme.
So the question I’m going to try and answer today is, can investors finally trust RBS, does the share price offer value at current levels, or is it a value trap?
Value trap red flags
There’s no set template we can use to try and determine whether or not a stock is a value trap, but there are several red flags which can provide an indication.
For example, value traps tend to have a high level of debt and low levels of cash conversion. Bad capital allocation decisions, such as value-destroying mergers and unsustainable dividends, are also hallmarks.
The way I see it, RBS doesn’t tick any of these boxes. Several years ago I would have said the company does have a high level of debt and low levels of cash conversion. But in recent years, the bank’s balance sheet has improved substantially, and regulators have been so impressed with its cash generation and asset quality they’ve allowed management to recommence dividend payouts.
The bank hasn’t pursued any expensive acquisitions either, concentrating solely on getting its house in order, trying to make up for past mistakes.
All of the above seems to indicate RBS is not a value trap. Of course, we can never be 100% sure, but none of the most common warning signs are there.
Time to buy?
As there are no clear red flags to tell me otherwise, I think the RBS share price could be an FTSE 100 bargain at current levels. Having said that, I think it could be some time before the market regains trust in this bank.
Even though RBS has come a long way since its state bailout during the midst of the financial crisis, the group’s past still haunts it, and I think it will continue to do for some time.
With that being the case, I think this is an opportunity only suitable for the most patient investors who are willing to sit back and watch RBS’s recovery continue. If the bank can continue to report impressive earnings growth for the next few years and rewards investors with fat dividends, the stock price should improve steadily from 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