A decade on from the financial crisis, is it time to start buying shares in the UK’s High Street lenders?
Assessing their value compared with rest of the FTSE 100, the answer would seem a resounding, Yes.
Looking at the likes of Barclays on 7.5-times forward (2019) earnings and Lloyds on 8.5-times (and yielding 6.5%) and the opportunities would appear to be too good to be true.
The latest stress tests carried out by the Bank of England’s Prudential Regulation authority appeared to give the High Street lenders a clean bill of health. But as always, the devil is in the detail.
Although fairly complex in its analysis, the headlines were quite simple.
Yes, the banks could withstand a Brexit-style shock allied to a series of other macro-economic mud pies. No, this wouldn’t require them to raise further funds.
But American investment bank Citi, in a recent note, said the issues around the UK clearers are poorly understood.
Possible dividend risks
There may be a risk to dividends if the lenders are to maintain capital requirements in line with what’s expected by the regulator.
As a result two big payers in the sector – Lloyds and HSBC – may lose some of their allure if their income stream slows to a trickle.
While it was the first time since 2014 all the major banks passed the stress test, Royal Bank of Scotland came close to missing the cut, while the shadow of litigation continues to follow Barclays.
All of this forgets normal-course-of-business issues such as a cyclical downturn in the economy that would lead to a rise in bad debts.
Technological tsunami for banking sector
Structurally, the industry is changing here in the UK. So, from an investment standpoint at least, let’s hope the banks can stay ahead of the technological tsunami as it rips through the sector.
And of course, there’re also the political issues to consider. Okay, Lloyds is out of State ownership, but RBS is still under the government’s yolk.
And then what happens if the shaky coalition between the Tories and the DUP collapses? This might usher in Jeremy Corbyn and unreconstructed ‘Trot’ John McDonnell as his chancellor.
Where else can investors find value?
So if not the banks then where in the FTSE 100 should one be sniffing truffle pig-like for value?
Well, not in the consumers staples, food and drinks sectors, according to James Sym, European equities fund manager at Schroders, one of the City’s biggest investment firms.
In a recent interview, he said these go-to stocks, which have become popular as bond yields have subsided, are now looking expensive.
Not just that; the likes of Nestle, AB InBev and Unilever are struggling to maintain growth and are subject to intensifying competition.
“My clients are being asked to pay the highest every price for those sort of companies just at the point where the fundamentals have never been so bad – they are unable to grow,” he said in his chat with the Thisismoney website.
“I have been encouraging people to think – if inflation comes back – do they have something in their portfolio that will protect against it? I think a lot of people don’t.”
Schroders’ Sym reckons the best value can be found in the “unfashionable and underloved” sectors.
This prompted the look at the banking sector, while the fund manager reckons the telecoms stocks are worth a closer inspection.
Insurers underloved
Unfashionable and underloved are descriptions you might equally apply to the insurance sector, which has been through its own financial shake-up, though certainly not of the magnitude of the banks.
And on a forward price-to-earnings multiple of 11.38 (according to Datastream), the sector is also cheap.
Two stocks that have come through the other end of the latest shake-up in rude financial health are stalwarts Aviva and Prudential.
Investors should be bullish on the former as the business has £3bn of excess liquidity to deploy, giving it the capacity to increase its dividends payments by double digits for “a number of years”, according to analysts at Barclays Capital.
Pru growth potential
Prudential’s growth potential, with large operations in the US and Asia, isn’t fully appreciated by the market.
"A ‘goldilocks’ economy should allow stable delivery of dividends; meanwhile fundamentals are improving for the reinsurers,” the Barclays analysts said in a recent 100-page note on the Pru.
“We expect prices to improve after record cat (catastrophe) losses, helping premium growth and profitability.
“A quality bias should still be justified – the prospects of slightly rising interest rates may not be enough to drive earnings strongly, while static yields are less attractive.”