Royal Bank Of Scotland (LSE: RBS) (NYSE: RBS.US) is due to announce its half-year results on Friday next week (2 August). I’m going to begin this preview with some words of warning for the less experienced investors among you.
“Consensus earnings forecast” has a reassuring ring about it, seeming to suggest that the City experts are in broad agreement about what earnings-per-share (EPS) number the company will deliver. And in fact, it’s often the case that most individual analyst forecasts are clustered fairly closely around the consensus.
However, on some occasions it behoves commentators like me to tell you that the consensus is next to meaningless. I’m going to show you exactly why this is the case with RBS, why investing in the company based on consensus earnings forecasts is high-risk, and what unwary investors could be letting themselves in for.
A lesson on earnings forecasts
The table below, based on data from the Financial Times, shows EPS forecasts for RBS for the year ending December 2013. We have the highest and lowest estimates and the consensus among the 27 City analysts who cover the company. And I’ve calculated the price-to-earnings (P/E) ratios as well.
The table also shows the same data for British American Tobacco (BAT). For clarity of comparison, I’ve adjusted the consensus EPS forecast for BAT to make it the same as RBS, and adjusted the high and low estimates for BAT on the same scale
| Â | RBS (recent share price 338p) |
BAT (hypothetical share price of 338p) |
|---|---|---|
| EPS high | 40.00p (P/E 8.5) | 22.55p (P/E 15.0) |
| EPS consensus | 21.74p (P/E 15.5) | 21.74p (P/E 15.5) |
| EPS low | 11.23p (P/E 30.1) | 20.68p (P/E 16.3) |
You can probably see where this is going now. In BAT’s case all the individual analyst forecasts are clustered closely around the consensus. Investors can have a high level of confidence that they’re paying around 15 to 16 times earnings to buy the shares.
In contrast, while the consensus EPS for RBS is the same as for BAT, there’s a big risk investors could actually be paying much more or much less than 15-16 times earnings: they could be paying as high as 30 times earnings or as low as 8.5 times earnings.
Now, if you’re an investor who can tolerate taking a higher risk for a potentially higher reward, you may be willing to back RBS on a consensus 15.5 times earnings, with a chance you’re actually getting the company on a dead cheap single-digit earnings multiple, but, equally, with the risk you could be paying through the nose at up to 30 times earnings.
More risk-averse investors may prefer to look at companies such as BAT where the P/E is unlikely to be far away from the consensus forecast; in other words, where there’s a very good chance that the earnings multiple you think you’re buying at will ultimately prove to be the true earnings valuation.
RBS’s upcoming half-year results
Again sourcing data from the Financial Times, I extrapolate the following forecast earnings numbers for RBS’s first half — albeit from a small pool of just three analysts:
| EPS | Forecast |
|---|---|
| High | 11.60p |
| Consensus | 9.94p |
| Low | 8.63p |
Looking beyond earnings, tangible net asset value is a potentially useful valuation number. However, the picture here is also muddy because RBS has been writing down the value of its assets since the financial crisis. The table below shows tangible net asset value per share at the end of the last six quarters.
| 31 Dec 2011 | 31 Mar 2012 | 30 Jun 2012 | 30 Sep 2012 | 31 Dec 2012 | 31 Mar 2013 |
|---|---|---|---|---|---|
| 501p | 488p | 489p | 476p | 446p | 459p |
The interesting thing here is the uptick in asset value during the first quarter of this year after a fairly inexorable decline. Keep an eye out for this number within next week’s results.
As things stand — on the 31 March number — RBS’s shares are trading at a 26% discount to the value of the bank’s assets: in theory, then, investors can currently pay just 74p for every £1 of assets — a bargain, on the face of it … if asset writedowns are bottoming out.
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> G A Chester does not own any shares mentioned in this article.