My investment in struggling Barclays (LSE: BARC) has not been very successful so far. At the time of writing, I’m down by 22.7%.
This isn’t necessarily a problem, of course. I’ve no need to sell the shares and if my investment thesis is right and Barclays’ performance improves, I should eventually make a tidy profit.
After all, on the face of it these shares are cheap. Barclays stock currently trades at a 43% discount to its tangible net asset value of 286p per share. The shares also have an undemanding 2016 forecast P/E of 11.
Here’s the problem
The apparent discrepancy between Barclays’ very cheap price/book ratio and its more normal P/E ratio tells you what the problem is — the returns from Barclays’ assets are too low. This is confirmed by the bank’s return on tangible equity, which was just 3.8% during the first quarter of 2016.
If Barclays shares traded at their tangible book value of 286p, then the bank would be valued on 19.2 times 2016 forecast earnings. That’s clearly too much, unless earnings are about to rocket higher.
I’m not sure that this is likely to happen. Although the bank’s adjusted earnings per share are expected to rise by 54% to 22.9p in 2017, next year’s profit forecasts have been cut by 22% over the last three months. Further cuts are possible.
Barclays is also cutting its dividend this year. The payout is expected to fall from 6.5p in 2015 to just 3.5p per share. Although this still provides a worthwhile 2.1% yield, it’s a bitter blow for shareholders — like me — who thought Barclays’ dividend would start to rise in 2016.
The problem is that Barclays has too many bad assets, which the bank prefers to euphemistically call “non-core”. These are cancelling out the decent returns from the bank’s good bits, such as the UK retail banking division, which generated a return on tangible equity of 20.5% during the first quarter.
The non-core challenge
The challenge for Barclays is to get rid of as many non-core assets as possible without incurring too many losses. This process has already taken longer than expected and could drag on for several more years. At the end of the first quarter, Barclays had £51bn of risk weighted assets which it classified as non-core. Only £3bn were disposed of during the first quarter.
It’s very hard for ordinary investors to understand exactly what’s included in the non-core category. Arguably, the only thing that defines a non-core asset is its poor performance.  In my view there’s also a risk that the contents of the non-core portfolio will be changed periodically in order to mask any performance problems with the bank’s core assets.
My decision
Barclays’ turnaround was always going to be a slow process. I’m prepared to wait as long as I believe the bank is making concrete progress. I still have some doubts about Barclays, but for now, I’m going to hold. I believe Mr Staley is serious about slimming down Barclays and improving the bank’s profitability.