Should I Buy, Hold Or Sell Royal Bank Of Scotland Group plc?

The shares of Royal Bank of Scotland (LSE: RBS) (NYSE: RBS.US) are up almost 13% on Friday at 2pm BST. I recently argued that the bank was meant to surprise investors, adding that RBS shares were likely to end up being the best performing shares in the British banking world.

At this level, RBS shares are not a bargain anymore, however.

Buy, Hold Or Sell?

On 30 June, this Fool said: “It’s not over yet, but RBS bears the hallmarks of a business that: a) has hit rock bottom; b) and may be ready to deliver more value than its competitors.” I also pointed out that the bank’s “impairment cycle” could have bottomed out. 

RBS stock is cheap based on most trading metrics, although before calling it a viable investment, RBS must prove it can operate as a private entity able to support hefty dividend payments. Impairment risk is still alive and well, although trends are very encouraging. 

In my view, there’s still a 10% to 15% upside left in RBS stock to the end of 2014, but any opportunistic investor with a long position in RBS may want to take profits now, as I expect weakness in its valuation in the next four to six weeks of trading. As far as its 2015 valuation is concerned, that depends on how swiftly interest rates will rise in the developed world. 

I may be wrong, of course. So, let’s see what City analysts had to say today after the surprise release that pointed to the highest level of profits since the 2008 bailout. 

Little Upside From Here? 

“Although we see material change to the path leading to a profitable “Future RBS” (…), we expect limited upgrades to ongoing earnings power. That said, we think the reaction this morning to results is justified. We expect an improvement to FV from capital and impairments of roughly 20p a share,” Nomura told its clients on Friday.

RBS itself said that it won’t be a smooth ride in months ahead, and I believe much of its fortunes hinge on divestments in the US as well as on how quickly the bank makes inroads in digital banking. Both elements could provide plenty of upside to shareholders looking for long-term value. 

A Significant Improvement?

“RBS pre-announced Q2 results, which are better than expected driven by better revenues and much lower impairments with significant net write. Regulatory capital ratio has materially improved, mainly due to good progress on RCR deleveraging,” Credit Suisse noted. 

(Please note that “RCR” stands for RBS Capital Resolution, i.e. RBS’s bad bank.)

“Supportive set of numbers with guidance revised up significantly, although the tone remains cautious, especially in the context of likely future litigation costs (Credit Suisse estimates £4.1bn of uncovered future litigation – i.e. about 100 basis points of CET1),” the broker added. 

RBS’s capital position is getting better, but regulatory hurdles represent a serious threat for any banking business in the current environment. The bank is “de-risking” its balance sheet, but its cost-cutting programme has determined the loss of key corporate clients, which will weigh on competitiveness and performance. 

Another risk is that the UK government must sell its stake over time. One option for RBS would be to bring in investors via a private placement which, if properly priced, may offer support to the shares.

For now, I’d cash in.