10 financial stocks with greatest turnaround potential

Ten years after the financial crisis engulfed world markets, some financial stocks are still recovering. UK banking shares that were once adored for their vast profits and bumper dividends remain shadows of their former selves. But in 2017 there's been a sense that things are improving across the financial sector, and it could be a happy hunting ground for turnaround investors.

This change in sentiment has been a long time coming. The 2008 banking crisis kicked off a decade of painful restructuring and recapitalisation. What started with chaos caused by bad loans in the US mortgage market ended with the longest period of constant low interest rates since before the First World War. So, it's no surprise that banks have struggled to recover.

Until recently, the financial sector has been the territory of brave value investors. Once-proud institutions were marked down heavily by the market, yet there was no obvious catalyst for a re-rating. But that's starting to change.

Rising rates in the US, and mixed signs from the Bank of England that rate rises could follow here, has breathed life into some shares. After a long period in the wilderness, some of these beaten up stocks have been picking up momentum.

Banking on a recovery

One of the lessons of the credit crisis was just how hard it is for investors to understand banks and their balance sheets. Royal Bank of Scotland was a brutal example of how arrogance ended in catastrophe. It went from reporting record profits to being bailed out within just eight sorry months in 2007.

The problems continue for RBS, but it's not the only one. Barclays escaped the need for a bail-out, but the choices it made over a refinancing have just landed those executives with fraud conspiracy charges. Meanwhile others, like Lloyds, appear to be nearing the end of their long rehabilitation.

So, while problems remain, there's a rough agreement that most banks are now in better financial shape than they were. Right now, a number of financial stocks - particularly those in banking, insurance and investment services - are showing a strong blend of factors that point to them being turnarounds.

In Stockopedia's classification of investment styles, turnarounds are the shares with the strongest combined exposure to both attractive valuation and improving price and earnings momentum. It's a category of stock that may not have strong financial quality but their value and momentum are nonetheless very powerful return drivers.

At the moment, there are 26 financial stocks in the top turnarounds list, and below is a snapshot of some of them.

It's important to say that not all these shares are recovering from crisis. Yet, as a whole, these stocks have been outperforming the market over the past year. Among bigger names like Standard Chartered, HSBC, RBS and Barclays, these rules find others in the sector like the challenger bank Aldermore and CYBG, the group behind Clydesdale Bank. Likewise, they pick up smaller insurance specialists like Chesnara and Randall & Quilter, which rub shoulders with larger players like Aviva.

Financial stocks beginning to find favour

Mark Carney, the Governor of the Bank of England, signalled recently that now isn't the time to be raising interest rates. So, the outlook for improving profitability in the banking sector is still not clear. Indeed, the unknown impact of Brexit and concerns about the strength of economy are nagging concerns for financial stocks.

Even so, there are signs that investors are taking a more optimistic view of banks and other financials. Improving sentiment over the past nine months remains intact. As these groups continue to move on from problems that started a decade ago, improving momentum suggests that the market is beginning to welcome them back.

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Interactive Investor's Stock Screening series is written by Ben Hobson ofStockopedia.com, the rules-based stockmarket investing website. You canclick here to read Richard Beddard's review of Stockopedia.com and learn more about the site.

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Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including "How to Make Money in Value Stocks" and "The Smart Money Playbook"

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.