There has been lots of current coverage of the credit crunch in the world wide press. With central bankers pumping tens and sometimes hundreds of billions of pounds and dollars back into the financial system to save it from the 'impending disaster'.
What caused this Credit Crunch? Most say that indiscriminate lending between mortgage lenders and banks, in a flurry of short profit seeking activities, spurred on a housing bubble in the United States, notably in Florida. When those that go suspect mortgages then began to default it was said to cause a reaction in the investment community as banks, hedge funds, private equity, investment banks and other related companies that had invested or were related to the sub-prime mortgage banks got hit.
What about the UK?
Northern Rock. If anyone mentioned this bank 2 years ago, in casual conversation, no one would really have thought much of it. It wasn't a large, multinational. And it had no problems. It was, however, vulnerable.
It had also been subtly involved in the crisis, announcing a hit in profits. What this caused was more important than any profit warning. Banks are build on consumer confidence, particularly smaller banks and building societies. The media propelled a 'run on the bank', with thousands of its' customers pulling out their savings out as soon as they could. Crowd behaviour and a lack of intervention on the part of the government meant that the bank went further and further towards bankruptcy. It has since somewhat been 'saved' by the government. That's not what I'll be focusing on here though, I'm interested in how this affects you and how you might be able to benefit from this crowd behaviour.
Contrarian investing behaviour and how to profit from it.
It has long been known that the best way to do well in Investing is to buy when others are selling. Simple, right? Well, most don't. Which is why some of the biggest, most diverse and stable banks in the UK(and in the USA) have also suffered from the Banking 'crisis'.
I'll be focusing on one of the UK banks that has been hit badly, whilst the underlying financial of the actual business aren't bad at all. I'll explain..
As some of you will know share prices do not reflect, as such, the success of a business, despite the fact that a simple glance at successful companies might suggest otherwise. If you were around in the dot com boom, and subsequent crash, you'll know that share prices can often mislead the average investor into believing the underlying business is doing well. For those new to investing, it isn't such a crime to believe it- its logical. Why would a terrible company have rising shares? Well. The first rule of investing, and in-a-way, the rule that may help you get rich, is that share prices don't follow logic, especially when looking at them in the short term. They go up, they go down. Sometimes terribly companies have high prices. My advice is forget about the stock charts and concentrate on what the underlying company is doing.
Back to the current situation
Royal Bank of Scotland (RBS) is the company that I'll be framing my current discussion around.
Contrary to some of the investing world I believe the bank will be fine, long term. Its share price tells a different story. At the start of 2007 the price of RBS's shares were over 700p. They are now standing at 344, at the time of writing. That is the same price as it was back in 2001 (not that I look at share charts, opps...).
So what's wrong with the bank? Nothing. Profits over the last 5 years have gone from £6B to £10B. In 2000 their profit was 4.4B. Might not sound much to the uninitiated, however, profits in large companies don't tend to double often, certainly not banks anyway. Back to this year, RBS' profit was near 10B, and it was supposed to be a bad year. Currently, I am not sure I agree.
RBS also own insurance companies and have recently bought ABN AMRO, a massive international bank that is likely to contribute to RBS' earnings nicely. Most banks in the UK, it has been recently announced have written off debt, but nothing that should spook investors out.
So why buy bank shares? I think bank shares are currently very good value. Currently RBS' p/e is under 5. Its dividend is very close to 10%. With increases of 10% a year, in 5 years your return, if you invest now, will be over 15%, annually, just for the dividend! This does not include the promising growth that may be achieved from the share growth. Its win win. If the share doesn't rise you've got a huge dividend income that smashes any bank account, ISA or bond to bits and if the shares do rise, if you invest soon then you'll have a good dividend and the chance to, maybe, double your money.
What will I do? I think I'll buy with a view to holding it. Credit crisis? No way..
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