Are Barclays’ shares a good investment?

Despite the ongoing financial crisis, it seems that bank shares are still a popular investment, and Barclays’ shares may be the most popular of all.  However, there’s more to investing than simply looking for what’s popular.

Of the UK banks, Barclays has –so far – coped with the crisis relatively well.  It hasn’t suspended its dividend, which for income investors is at least something.

But just like the other banks, Barclays’ shares have taken a colossal hammering.  Before the crisis, the shares were about to reach 800p, while at their lowest in 2009, they almost touched 50p.

Investors who were brave enough to get in at the moment of maximum fear have had a good run back up to around 300p or so.  But the shares have been falling again for the last three years, and we are, of course, still well below the old highs.  Does this in itself signal a great bargain?

What is an investment anyway?

First of all, let me define what I don’t mean by “investment”.  What I don’t mean is the purchase of some shares in the hope that the shares will go up in the next year.

You may be surprised, but generally, I’m not looking for anything much to happen at all.  Actually, I prefer it when things are relatively uneventful.  Instead of looking for excitement, I’m focused on buying good companies at low prices.  Companies which – over many years – can be expected to sell more, earn more profits and pay more dividends back to me.

If, at some point down the road, Mr Market decides to get excited about the company and bid the shares up excessively, then I’m happy to sell and bag the additional profits.  But that is not my intention at the outset.

The reason for this oh-so-dull approach is that history and piles of academic studies have shown that pretty much all investors are very bad indeed at knowing what will happen to any given company and its shares in the short term (which I class as anything less than five years).  On the other hand, the long-term may be far more predictable.

Looking beyond the share price

Looking at Barclays’ share price and how it’s changed in relation to itself is pointless.  What really matters is how the current share price relates to the amount of cash that the company is able to return to investors over time.  Here is what Barclays’ shareholders have seen, in terms of earnings and dividends per share, in the last decade.

That is not the happiest of charts.  It tells a sorry tale of a company nearly falling off a cliff.  The share price mirrors the trials and tribulations of the business, peaking in 2007 and falling into the abyss in 2009.

Do turnarounds turn?

The first problem that I have with Barclays is that it’s a turnaround situation.  I’m not a big fan of turnarounds, even though they’re a favourite with many value investors.  Personally, I prefer to avoid trouble and stick with companies that are cheap and still performing well.

On that basis alone, I think I’d probably avoid investing in Barclays’ shares, but let’s carry on anyway and see what else comes up.

Assuming we’re still interested, what can we assume for the future of Barclays?

If we use simple extrapolation, then it doesn’t look good.  The company has effectively shrunk its returns by about 12% a year in the last decade.  Roll that forward long enough, and Barclays will effectively become worthless.

Of course, it’s overly simple to extrapolate the past, so what if I were optimistic and said that the next decade would look like the past decade in reverse?

Let’s stick with that optimistic scenario and use it to work out if the shares are attractive at their current price of around 300p.

Estimating the future

In the last ten years, and therefore in the next ten years in our optimistic scenario, Barclays earned an average of 30.5p per share.  With the shares at 300p, that puts the current price at 9.8 times the average earnings for the next decade (again, using this optimistic scenario).

9.8 times future earnings is not a bad multiple, but it’s a long way from the best, especially given the uncertainty around whether or not this level of earnings will actually appear.

Looking at dividends, the average dividend in the last ten years was around 16p.  That’s an average yield of 5.3% over the next decade relative to the current 300p price tag, but it does require the dividend to more than double from today’s level.

Cheap if things turn out well, not so cheap if they don’t

A PE ratio of 9.8 and a dividend yield of 5.3% are both good numbers.  If Barclays can achieve those earnings and dividends sustainably through the next decade, then a 300p today doesn’t look too bad, at least on the face of it.

The problem is that it may be many years before those results arrive, and there is, of course, much uncertainty about the timing of their arrival.  Will it take three years or 10?  What if it takes more than a generation for us to see a banking boom like the last one?

On the other hand, there are shares of good, solid companies available right now with yields at or above 5%, and that’s using current earnings and dividends, not some optimistic guestimate of what Barclays may be able to produce in the distant future.

The question for me is this:

Why would I want to invest in Barclays, where I need things to turn around and get better to justify the price, when there are other businesses available on more attractive terms that have no need for a turnaround?

Having said that, I think that if Barclays’ shares got down below 150p, then I might be tempted.