UK and European banks are "in better shape than at any point" during the past 25 years, according to JPMorgan, and offer upside for investors.
Overall, shares in the European and UK banks have risen 8% so far in 2024, with NatWest Group PLC (LSE:NWG), Barclays PLC (LSE:BARC) and Lloyds Banking Group PLC (LSE:LLOY) in the top three in the year to date.
But the sector is "still cheap" at around seven times forecast earnings for two years ahead (2026) compared to the broader European market on a 13 p/e ratio.
This cheapness reflects the lack of pre-tax profit growth, the JPMorgan analysts said, compared to historical levels of 8.2 times two-year forward p/e.
Therefore the sector offers "14% upside potential plus a high sustainable cash yield of almost 7% and total yield including share buybacks of almost 11%".
The JPM analysts see European banks are in better shape than they have been in decades due to their robust capital positions, lower leverage, and limited concerns over asset quality.
However, the despite the potential 21% total return, "we caution against becoming 'uber bullish'," the analysts said, due to its high leverage "the sector should always be valued well below the market, limiting its re-rating potential."
JPMorgan prefers a 'bottom-up' approach to selecting banks, looking a potential for growth in non-interest income, cost control, and high cash payouts.
Barclays is one of its five top picks, along with UBS, Deutsche Bank, UniCredit and Intesa Sanpaolo, with Italian pair UniCredit and Intesa offering total payout yields of 16.7% and 12.3% annually for 2024-26.
NatWest drops out of the top picks as the analysts see "the re-rating of UK domestic banks as mainly finalised" with NatWest the best performing bank in Europe this year.