The firm, which owns the Arbuthnot Latham & Co merchant bank in London, posted a healthy rise in underlying pre-tax profit for 2018, up from 2017’s £3.2m to £7.4m.

Underlying earnings per share (after adjusting for an accounting loss of £25.7m from the derecognition of Secure Trust Bank as an associated undertaking) came in at 40.3p per share, up from 17.6p a year previously.

Net assets per share did fall, from 1,547p to 1,283p, but at a share price of 1,355p, that looks fine to me.

All in all, chairman and chief executive Sir Henry Angest seems quite conservative, saying: “The group has had another good year.” Sir Henry also pointed to Arbuthnot’s new ventures, adding that they “should give the group a strong basis from which to develop in the future.”

Valuation

After a 4% share price rise on the morning of the results, and based on that underlying EPS figure of 40.3p, we’re looking at a trailing P/E of 34. To say the least, that’s high for a bank.

Very strong EPS growth forecasts for the next two years would drop that to around 17 by 2020, which you might think is still high. But, catering to high net worth individuals and businesses, Arbuthnot isn’t exposed to the same risks as its high street counterparts.

There are hardly going to be any mortgage default risks, and the bank should be pretty much immune to anything Brexit could throw at the economy. Add on Arbuthnot’s progressive dividends, and I see a long-term buy here.

Recovery?

I wish I could view Metro Bank (LSE: MTRO) with the same degree of comfort, but its financial acumen doesn’t appear to compare too favourably with Arbuthnot.

After launch, the challenger bank’s shares soared as investors saw enticing growth prospects. By mid-2018, we were looking at eye-watering prospective P/E multiples of more than 50.

But my colleague Rupert Hargreaves saw the writing on the wall as early as May that year. He pointed to feared weakness in the bank’s balance sheet and suggesting that Metro must “either raise more capital or put the brakes on growth.”

Collapse

That was prescient, and the subsequent share price collapse was made worse by the revelation of an accounting blunder that incorrectly classified the risk associated with millions of pounds of loans. The error was uncovered by banking regulators, and the Prudential Regulation Authority and Financial Conduct Authority are looking into it.

Plans to shore up the balance sheet with a £350m equity issue pushed the shares down even further. But that has raised the tempting prospect of a possible share price recovery, with analysts still offering upbeat earnings growth forecasts. That would put the P/E at 19 this year, dropping to 15 by the end of 2020.

If you’re brave enough to handle the risk, I think you might be on to a good thing if you buy now. But these recent shenanigans are not what I want when I think of a banking investment, so I’m keeping away myself.

It reached a significant landmark in its recovery last week when, for the first time since the financial crisis, RBS paid a dividend.

Time to buy?

RBS’s return to the dividend club should not be underestimated, in my view.

The fact that management is now confident enough to start distributing retained profits shows that they believe the bank has rebuilt its capital reserves to acceptable levels. What’s more, the reintroduction of the payout indicates that management is optimistic about the future for the enterprise.

Earnings per share (EPS) are forecast to increase by 35% for 2018, followed by growth of just over 5% for 2019. In the years after, there are plenty of tailwinds that could help the bank continue its growth streak. For example, the PPI deadline, and rising interest rates, should lead to more profitable trading conditions in the near term. 

Given this growth outlook, shares in RBS appear to offer good value, trading at a forward P/E of just 9.

And what about the dividend? Well, after its token 2p per share interim payout, analysts are expecting a second final dividend of around 4.5p for 2018, giving a full-year payout of 6.5p. Next year, a full-year distribution of 9.2p is predicted as management ramps up efforts to reward long-suffering shareholders. Based on these predictions, a potential dividend yield of 4.1% is on offer for 2019.

Slow and steady 

RBS looks to offer good value at current levels, but many investors remain cautious about the group’s outlook, due in part to its troubled history. If this puts you off, in my opinion, Arbuthnot Banking (LSE: ARBB) has similar attractive investment qualities.

Shares in Arbuthnot trade at a premium compared to RBS because the company has a stronger record of profitability. Unlike RBS, it’s been consistently profitable for the past six years, and analysts are predicting EPS growth of 33% in 2018, followed by an increase of 55% for 2019.

While these figures do suggest a pricey forward P/E of 23, the stock’s PEG ratio of 0.4 indicates to me that the shares are undervalued, based on Arbuthnot’s growth potential. In a trading update published today, the company confirmed that it’s on track to meet the City’s growth targets for the year.

On top of its growth potential, Arbuthnot has also earned a reputation as a dividend growth stock over the past six years. The payout has grown at a steady 6% per annum since 2012, and with EPS set to leap 33% in 2018, I’m confident this trend will continue. 

With this being the case, now could be the perfect time for dividend growth investors to buy Arbuthnot.

Indeed, most investors fail to meet this objective, and even the professionals struggle. However, I’m confident that I’ve found two companies that can help you achieve this objective because they already have a history of doing so. 

A challenger rises up 

Shares in challenger bank Arbuthnot Banking Group (LSE: ARBB) have smashed the FTSE 100 over the past five, 10 and 15 years. Whichever period you look at, the shares have racked up a market-beating performance. 

According to market data provider Morningstar, over the past 10 years the FTSE 100 has produced a total annual return for investors of only 4%, and 4.2% over the past 15 years. Meanwhile, Arbuthnot’s stock has returned 23% per annum since 2008, and 11.5% since 2003. 

I see this performance continuing. City analysts are expecting the bank to report EPS growth of 25% for 2018, and an increase of 67% for 2019. With profit up 40% in the first half of 2018, it looks as if the bank is well on the way to meeting these figures, and possibly even beating the City’s EPS growth target for the year. I’ll be keeping an eye on analyst estimates over the next few months to see if they’re revised higher. 

To help drive growth, Arbuthnot also revealed today that it’s looking to establish a new lending division called Arbuthnot Specialist Lending. 

All in all, it looks to me as if Arbuthnot is firing on all cylinders. With the stock trading at a PEG ratio of only 0.4 — a ratio of less than one indicates the shares offer growth at a reasonable price — they seem cheap compared to the challenger’s expected growth rate. On top of its attractive valuation, Arbuthnot’s stock also yields 2.2%. 

All of the above indicate to me that Arbuthnot can continue to outperform the FTSE 100.  

Packing profits 

Packaging company Macfarlane (LSE: MACF) is another FTSE-beating champion I like. Over the past 12 months, the shares have more than doubled in value, easily beating the FTSE 100’s 2.9% gain (excluding dividends).

Over the past five years, the performance is even more impressive with the stock up 200%. Earnings growth has been the driver of returns. On average over the past five years, EPS have expanded at an average annual rate of 19%, and City analysts are expecting the growth to continue. 

The City is estimating EPS growth of 32% in 2018 and Macfarlane seems to be well on the way to hitting this target. “Group profit for the year to date is well ahead of that achieved in 2017,” a trading update issued before the firm’s AGM in May noted. “Recognising the influence of the online retail sector in the second half of the year, the Board is confident that Macfarlane will perform in line with its expectations for 2018,” the update continued. 

Based on current growth estimates the shares are trading at a forward P/E of 14.4, which isn’t too demanding in my view. Considering Macfarlane’s track record of growth, and future outlook, I believe its FTSE 100-beating performance can continue.

Banking on growth

Today Arbuthnot published its audited final results for the year to 31 December and these look like a decent set of numbers. The bank highlighted “increased profitability as capital successfully deployed,” with a 91% jump in underlying profit from £4m in 2016 to £7.7m. Operating income increased 32% to £54.6m.

Earnings per share soared from just 3.7p to 43.9p, although the 2016 figure excludes profit from discontinued operations of £228m. Similarly, while the full-year 2017 dividend per share rose from 31p to 33p, last year’s figures excluded special dividend payments of 325p. Underlying net assets crept up from £234m to £236m.

Challenging times

Chairman and chief executive Sir Henry Angest hailed the “creditable milestone of surpassing £1bn in its key business metrics: Customer Loans, Customer Deposits and Assets under Management,” and added that with strong capital and a good liquidity surplus, Arbuthnot “is well set for further growth.”

City analysts are pencilling in EPS hikes of 76% in 2018 and another 75% in 2019. By then, the yield is predicted to hit 3%. A forecast valuation of 15.3 times earnings does not look too demanding. Recent share price performance has been patchy, but Arbuthnot is rising to the challenge.

Scaling up

With a market cap of just £198m Arbuthnot is small beer compared to Royal Bank of Scotland Group (LSE: RBS) at £30bn. However, the market still does not totally believe in RBS, whose shares continue to struggle, despite finally reporting its first bottom-line profit in a decade for last year.

RBS posted a full-year operating profit of £2.24bn, reversing 2016’s huge £4.08bn loss, while profit attributable to shareholders of £752m turned round a massive £6.95bn loss. However, it was flattered by the fact that a multi-billion dollar mortgage mis-selling case with the US Department of Justice was not settled in the period, as this would have pushed the bank into another loss.

Income play

RBS does still not pay a dividend, but that is set to change. This year, the yield is forecast to hit 2.9%, then jump to 5.2% in 2019. When the dividends start flowing, investors might finally start believing that RBS is back for good. It will remain a bumpy ride, with EPS forecast to be flat last year (after 2017’s dizzying 385% growth) then rise 12% in 2019.

The banking sector is also exposed to further economic and Brexit uncertainty, and the slowing housing market. Net interest margins, which measure the difference between lending and saving rates, fell five basis points to 2.13% in 2017. However, with further base rate hikes expected, it may have scope to widen this again. The bank’s legacy issues are not dead, but they are slowly fading away.

But while the likes of Lloyds Banking Group are getting back to healthy growth, HSBC shares have been falling back — over the past five years, Lloyds shares are up 42% while HSBC’s are actually down 1%. And since the start of 2018, it has been the worst performer with a fall of 9%.

HSBC has actually been through a tricky process of restructuring since the crisis. While nowhere near needing a bailout, it was a bit overstretched and undercapitalised, and it’s a significantly leaner operation these days — though not without pain.

Full year

HSBC’s 2017 results were hit by loan impairments rising to $658m, partly due to the collapse of Carillion. But revenue reached $51.4bn, from $48bn a year previously, and pre-tax profit soared from $7.1bn in 2016 to $17.2bn. Part of that improvement came from a strengthening retail division performance, and that’s pretty much where banks are looking these days to lower their risk and protect their balance sheets.

Analysts are forecasting a return to sustained earnings growth, and that should lead to a strengthening of HSBC’s dividend progress. We’re currently looking at a predicted dividend yield of 5.4% for 2018, which would be covered 1.4 times by earnings. That looks good enough to me, though it is below cover from Lloyds.

And HSBC is planning to return further capital to shareholders, after the bank completes its raising of alternative tier one capital through a new debt issue — which is to meet some arcane regulatory requirement. The tier one capital ratio stood at 14.5 at year-end, so there’s no real concern.

Tempting challenger

Whenever I’ve looked at Arbuthnot Banking Group (LSE: ARBB), I’ve always believed it to be a well-managed operation.

The challenger bank has been recording losses per share for the past two years, but the City’s experts appear to think it is on the verge of something special. From an admittedly low base, EPS is predicted to grow by 76% in 2018, followed by a further 75% the year after — which puts us in the unusual position of seeing attractive growth metrics in the form of very low PEG ratios, from a bank.

Before that we’ll have 2017 results on 28 March, and forecasts suggest EPS of around 46p per share — anything better than that, and I reckon we might see an uprating of the share price. As it stands, if results come in according to forecasts, Arbuthnot’s P/E would drop as low as 9.3 by 2019 should the share price remain unchanged.

Future health

I don’t think there’ll be any surprises in 2017’s figures, as the bank’s February pre-close update assured us that pre-tax profits should be in line with market expectations after it “continued to trade well in the fourth quarter of 2017.“

We were also teased by the prospects of Arbuthnot diversifying by investing in the launch of new businesses in 2018, and I’ll be watching for further details.

At the moment, I think it’s clear that shares in the UK’s banks are still being held back by the uncertainties of Brexit, but the closer we get to clarity on the divorce, the more I think we’ll see how undervalued players like Arbuthnot really are.

Today the firm announced that it had continued this record of growth with adjusted operating profit rising 6% in its fiscal first half. 

Asset management growth 

What has allowed Close Brothers to outperform its peer group over the past few years is its asset management business.

Asset management tends to have higher margins than traditional banking, which relies on the size of the net interest margin — the difference between what rate the bank can lend at and the rate it pays to depositors — that can vary from year-to-year. As asset management also involves managing client money, rather than lending out funds, it is also more profitable because Close Brothers does not have to foot the bill if there’s a default, as it does with loans. The bank’s bad debt ratio for the first half of 2018 was 0.7%.

That being said, Close Brothers has a disciplined approach to lending and prefers quality to quantity, which is why the group’s book grew at a relatively sedate 7% year-on-year during the half during the half compared to positive net flows of £573m in the asset management business representing an annualised rate of 13% of opening managed assets. Thanks to higher inflows, the company achieved a 25% increase in adjusted operating profit for asset management during the period. 

For the full year, yet to be reported, City analysts are expecting the company to turn in earnings per share growth of 4.6%. On this basis, the shares are trading at a relatively attractive forward P/E of 11.8 and also support a dividend yield of 4%.

So overall, based on Close Brothers’ record of historical growth and its future potential, as well as the bank’s attractive valuation, I believe that the shares could be an excellent buy for your portfolio today. And another fast-growing back I’m positive on the outlook for is Arbuthnot Banking (LSE: ARBB). 

Defensive banking 

One of the UK’s fast-growing challenger banks, Arbuthnot has put in a mixed performance over the past five years, but City analysts are expecting big things from the company over the next two.

Specifically, analysts have pencilled in earnings per share growth of 75% for 2018, indicating that the shares are trading at a forward P/E of 16.4.

Arbuthnot is relatively complicated to understand because the private bank has many moving parts. For example, during the first half of 2017, the firm booked £2.1m of income from its 18.6% share of Secure Trust Bank. Meanwhile, net asset per share fell nearly 20% thanks to the payment of a £44m special dividend. On the plus side, customer deposits and assets under management passed the £1bn milestone.

But despite all of the complexity, I believe that Arbuthnot’s assets under management will continue to grow as savers and investors continue to move away from high street banks to more bespoke offerings. What’s more, private banks tend to be less exposed to harmful economic trends thanks to their wealthy client base.

However, I believe that the majority of these concerns are unwarranted. Challenger banks such as OneSavings (LSE: OSB) have carved out a unique niche for themselves, and the market’s hostile attitude towards the sector has pushed valuations down to highly attractive levels. 

Robust growth 

This morning, Arbuthnot Banking Group (LSE: ARBB) reported that for the three months to September, overall loan volumes have risen by 75% over the year-ago period — the kind of growth that the UK’s big four high street banks would kill for. 

The financial services company also reported 33% loan book growth for its private bank subsidiary, Arbuthnot Latham. Moreover, the group’s commercial bank division is now planning to launch an infrastructure fund to capitalise on demand from investors for such assets. 

And as the top line is growing, the group’s costs are also falling. According to today’s trading update, the overall cost of funds for Arbuthnot Latham has fallen by 30% from the prior year to a blended rate of 0.49%, due to the Bank of England’s term funding scheme. 

Dividend potential 

Overall, this is an excellent update from the company. Higher demand for loans coupled with a lower cost of funding means wider margins, and I believe that this growth should help turn the group into one of the market’s dividend champions. 

According to current City forecasts, Arbuthnot is on track to earn 49p per share this year, and 82p per share for 2018. Analysts have pencilled in a dividend payout of 33p per share for 2018, but considering the firm has historically paid out 70% of earnings to investors via dividends, I believe a dividend of 55p to 60p is more likely. As the financial business continues to notch up revenue growth, the dividend could hit 70p or 80p by 2019, up 100% from current levels. 

At the time of writing, shares in Arbuthnot trade at a 2018 P/E of 15.2. 

Undervalued dividend 

OneSavings is probably the most unloved challenger. Even though the bank is on track to grow earnings per share by 15% for 2017, the shares only trade at a forward P/E of 8, falling to 7.4 for 2019. What’s more, the shares support a dividend yield of 3.5% with the payout covered 3.5 times by earnings per share. 

The banking sector trades at an average forward P/E of 10.2 so, if OneSavings’ shares move back to the average sector valuation, investors could be looking at an upside of  38% from current levels. 

There’s also plenty of scope for the company to increase its dividend payout. 

With a reported Equity Tier 1 capital ratio of more than 13%, the bank has a strong balance sheet and can afford to ramp up cash payouts to investors. According to my figures, a doubling of the payout to 27.2p would still leave the distribution covered twice by projected earnings per share, and the stock would support a dividend yield of 7.2%. 

Better than cash in the bank

If you want a bank dividend that was untroubled by the financial crisis, look no further than Arbuthnot Banking Group (LSE: ARBB). Yields might not have been high, but the occasional special payment more than makes up for that.

The year just ended in December 2016 was no exception, with ordinary dividends lifted 6.9% to 31p — for a yield of 2.1% on today’s share price of 1,476p.

But that was overshadowed by the payment of special dividends during the year of 325p per share, which is pretty impressive for a bank that saw net assets per share rise by 23% during the year and climb nearly sevenfold in the past six years. If you want to invest in a company that’s good at generating cash, you could do a lot worse than going for Arbuthnot.

The rest of the figures looked impressive too, with Arbuthnot Latham customer deposits up 11% to £998m, written loan volume up 39% to £227m, and assets under management up 16% to £920m.

Chairman and chief executive Sir Henry Angest described the year as a “momentous and highly profitable” one, in which a number of corporate transactions should allow it to develop over time “into a more significant private and commercial bank“.

What about valuation? We’re looking at a 2018 P/E of a bit over 18 based on current forecasts. That looks a bit high by long-term FTSE standards — and it’s around twice the valuation of Lloyds Banking Group.

But Arbuthnot might just be the best managed bank out there.

Long-term strength

IFG Group (LSE: IFP) shareholders seem less pleased today as their shares dropped 9% to 136p, after the financial services group revealed a fall in 2016 profits which was blamed on falling interest rates.

While the group’s James Hay and Saunderson House subsidiaries saw combined revenue perk up by 10% to £78.5m, overall pre-tax profit from continuing operations fell 26% to £6.4m and IFG’s adjusted earnings per share dropped by 7% to 7.57p. 

There were exceptional costs to the tune of £1.7m too. But the reaction looks a little overdone to me, as the balance sheet firmed up a little with net cash up 3.3% to £28.2m and there’s no debt on the books. Chief executive John Cotter said: “We enter 2017 with both businesses in stronger positions than last year” and spoke of “positioning the group for sustainable growth“.

Forecasts do make the shares look attractive, with two strong years of earnings growth dropping the P/E to only around 12.5 by 2018. We’re also looking at attractive PEG valuations of 0.3 this year and 0.7 next, and it’s pretty rare for a financial services firm to exhibit attractive growth prospects like that.

But it’s the long term that counts, and I see see IFG’s progressive dividend policy as a big plus, with a 2018 yield expected to reach 4%. The firm’s markets, serving high-net-worth clients, should also be quite lucrative over the next decade and more, and I see IFG as one to buy and tuck away for years.

Extra cash

While dividends at the big banks are coming under pressure, Arbuthnot Banking Group (LSE: ARBB) has today announced a special dividend of £3 per share to be paid on 18 November — but you’ll have to be on the shareholders register by 21 October.

The first half of the year saw the sale of Everyday Loans and of a 33% stake in the firm’s Secure Trust Bank, netting a total gain of £217m — and a total first-half profit of £225m. Some £45m of that will be used to fund the latest dividend, which comes on top of a 25p per share payment announced at the interim stage and paid in July.

More of the cash is to be used to accelerate the firm’s expansion, with new premises opening in Manchester and an expectation of having “a further six commercial bankers in place by early 2017.” The “disruption in the larger UK banks” has apparently led some top experts to head in Arbuthnot’s direction.

The firm will see a short-term fall in its net interest margin after the base rate was cut, and the longer term is uncertain, but is Arbuthnot a good buy? Despite a sharp fall after the referendum, the shares have regained their loss to reach 1,648p. With earnings erratic in the short term, fundamental valuations are hard to follow and we’re looking at a 2017 P/E of well over 20 — but the firm’s cash generation and dividends do look tempting.

The new kid

Or how about newer challenger Virgin Money Holdings (LSE: VM)? Unlike the big banks, Virgin isn’t saddled with bad debts accrued during the banking crisis, isn’t constantly looking over its shoulder for regulators wielding notices of fines, and doesn’t twitch every time the phone rings in case it’s yet another PPI claim.

Virgin’s share price tumbled in the days after the Brexit vote, but a steady recovery to today’s 310p leaves it down just 15% overall — and that gives us a forward P/E for this year of 10, dropping to a little over nine on 2017 forecasts. Dividends are low with yields of only around 2% predicted, but they’re strongly progressive, with rises of 18% and 22% on the cards for this year and next, and they’d be very well covered by earnings.

As a small fish in a big pond, Virgin Money has the potential to grow very quickly in the next few years. And the bank’s targeting of the UK mortgage market is a strategy that I think has success ahead of it — at the halfway stage this year, gross mortgage lending was up 19% on the first half of 2015, to £4.3bn, with net lending in the half up 29%.

Credit card and retail deposit balances were both on the way up too, growing 31% and 8% respectively, and in the month after the referendum the bank had seen “no evidence of changes in customer behaviour.“

I like the look of Arbuthnot for the long term, but I like Virgin Money better.

Although Barclays’ near-term future is rather uncertain, given the challenging outlook for the UK economy, its longer-term potential remains high. Its new CEO is set to implement a refreshed strategy that should see Barclays’ financial standing improve and with it being a global bank, a downturn in the UK economy may not hit it as hard as the market currently believes.

Certainly, Barclays’ decision to reduce dividends has hurt investor sentiment and it seems unlikely that the bank will become a strong income stock in the short run. However, with profit due to rise next year and it having a sound strategy, its current valuation seems to make it a value play rather than a value trap.

Wait and see

Also trading lower after the EU referendum are shares in Arbuthnot (LSE: ARBB). The bank’s valuation has fallen by 15% since the UK decided to leave the EU and, like Barclays, its near-term forecasts are likely to come under pressure as the UK faces the real threat of a recession.

With Arbuthnot being heavily UK-focused, its retail and private banking offerings could be hurt over the medium term. Therefore, while it’s forecast to record a 232% rise in earnings this year, there’s a very real possibility that this figure could be downgraded over the coming weeks and months. Likewise, Arbuthnot’s expected fall in earnings of 32% next year may prove to be a rather modest forecast.

Due to Arbuthnot trading on a forward P/E ratio of 11.4, many investors may be tempted to buy-in following the recent share price fall. However, it may be prudent to await further news flow on the state of the UK economy before doing so. That’s not to say that Arbuthnot is necessarily a value trap, but rather that it lacks a sufficiently wide margin of safety to merit investment.

Emerging markets exposure

Meanwhile, Prudential (LSE: PRU) has seen its share price fall by as much as 19% since the EU referendum. However, it has recovered somewhat to now be down by around 12%, but even so its international focus means that it’s in a strong position to overcome any downturn in the UK economy.

In fact, the main driver of Prudential’s share price over the coming years is likely to be its exposure to the emerging world. This presents a major opportunity since the wealth and size of the middle class across the developing world is likely to rise rapidly in the coming years. With Prudential well-positioned in a number of key markets, it should be able to capitalise on this growth trend.

Prudential’s P/E ratio of 10.3 therefore indicates that it’s a value play rather than a value trap. Its near-term share price volatility may be high, but for long-term investors it’s a bargain.