As an investor, I often need to try to anticipate what will happen in the future. And inflation is therefore very interesting to me. It’s becoming clear that inflation may not be transitory as was hoped by policymakers. If inflation persists though, it may help bank shares, which puts them on my radar as I seek additions to my portfolio.
Positive sector results
Recent results from HSBC and Barclays show that the banks are bouncing back from a tough 2020 – arguably better than other sectors that were hit by the pandemic. Profits at HSBC rose 74% in the third quarter. Barclays announced that in the same quarter, its profits before tax rose to £6.9bn – a record amount for the three-month period.
These results show that the banks are doing fairly well, but there could be room for more share price growth. Increased optimism over the recovery of the economy is an obvious potential catalyst.
As well as the potential for share price growth, there’s the income that banks can provide to take into account. On top of their reasonable yields, the latest AJ Bell Dividend Dashboard shows that among FTSE 100 companies three banks, HSBC, Barclays and Lloyds will be among the 10 listed groups that will pay investors 80% of FTSE 100 dividends in 2021. This proves that dividend growth is back on the cards after the pandemic led to dividend suspensions.
Trip hazards to watch for
It’s worth being mindful that very successful investors such as Terry Smith have generally been unenthusiastic about investing in banks, principally due to their complexity and use of debt. They also have to hold huge amounts of capital because of increased regulation introduced after the Credit Crunch. Bank share prices are also very tied to the health of the economy. As such, they’re not necessarily the highest-quality buy-and-hold investments, especially in challenging economic conditions.
Bank shares poised for major growth?
The UK’s listed banks are mainly huge institutions with correspondingly large market capitalisations. As the saying goes, “elephants don’t gallop”. So huge share price growth from these stocks is, I think, unlikely. What’s quite possible is that a recovering economy, a buoyant housing market, and the possibility of small, incremental interest rates rises all combine so that shares in the banks outperform the wider market. I think this is perfectly possible.
There are, of course, smaller banks as well, which should be more agile than their bigger peers. They could, if things go well, see larger share price growth. Examples I can think of are Arbuthnot and Metro Bank. The former has a market cap of just £133m while Lloyds’ market cap is approaching £35bn.
I don’t think bank shares are worth buying only because of the potential for a rise in interest rates. Instead, the combination of potentially substantial share price growth and higher than average dividend yields are the big attraction. I may be particularly tempted to buy Lloyds or one of the more specialised smaller players.