Eight years after the Financial Crisis and shares of Lloyds (LSE: LLOY) still trade at 85% below their 2007 peak. Having failed to cross the £1 per share threshold since 2009, investors would be forgiven for losing patience with the state-backed lender. But, with analysts across the City labelling the bank a conviction buy, are shareholders finally about to be rewarded?
The last eight years have certainly been rough for the bank, but all this time spent raising capital buffers and settling regulatory fines has left it in better shape than most large rivals. A core capital ratio of 12.8% puts it above required levels and is high enough to allow a return to high dividend payouts to shareholders. And the £4bn set aside in 2015 for PPI misselling may be the last of the £16bn that has flowed out of Lloyds’ coffers to settle claims.
Further adding to optimism is the lender’s successful reorientation back towards domestic retail banking. Lloyds now controls nearly 20% of the UK mortgage market and has benefitted greatly from the relative strength of the domestic economy. Underlying profits of £8.1bn in 2015 reflect this, as does the company’s enviable 15% return on equity.
On paper, the bank looks like a surefire winner going forward, but shareholders shouldn’t expect massive growth. Shares already trade at their book value, an important metric for banks that suggests Lloyds will need to boost the top line to send shares upwards. However, with a strong focus on an already saturated UK market, revenue growth won’t be staggering in the near future.
That being said, the forecast dividend yield of 6.4% for 2016 is attractive, especially since it’s nearly twice covered by earnings. So, while current shareholders may not see much growth in share prices, they can at least expect a great yield from a relatively safe and reliable business.
Stability or growth?
Like Lloyds, pharmaceutical giant GlaxoSmithKline (LSE: GSK) is just emerging from several years of rebuilding. With share prices where they were in 2005, investors are certainly hoping that analysts are correct in forecasting a return to earnings growth in 2016 after four successive years of declines.
GSK is in good shape to meet these expectations as a slew of new HIV treatments brought in £2.3bn in 2015 and provided a full 29% of operating profits. These new drugs could finally replace the sales missed from losing the US patent to blockbuster respiratory treatment Advair.
Yet critics will point out that core operating margins, which ignore the effects of disposals, continued their decline to 23.9% from 30.4% just three years ago. This decrease reflects management’s decision to pivot towards selling more low-margin consumer health goods and vaccines. While these business lines, which account for 42% of revenue, bring in more reliable income, they fail to offer the sky-high profits blockbuster drugs do.
Looking ahead, the shares still trade at a relatively pricey 16 times forward earnings and high growth isn’t to be expected. This valuation doesn’t make GSK a bargain, but a healthy 5.9% yielding dividend and relatively reliable earnings help explain why GSK is a mainstay in dividend fund portfolios.