NatWest shares have dived since August

As I write (on Monday afternoon), the NatWest share price stands at 232.1p, up 7.2p (3.2%) today. This gain makes NatWest shares the third-biggest riser in the FTSE 100 index today. However, this popular stock has fallen hard since hitting its 2022 peak in the summer. Here’s how NatWest stock has performed over six timescales:

Shares in the former Royal Bank of Scotland group have bobbled up and down over the past 12 months, but have lost nearly a quarter of their value over five years. (These figures exclude cash dividends, which would boost returns by a few percentage points a year.)

Yet on 17 August, NatWest shares were riding high, hitting their 2022 intra-day high of 284.42p. Since then, they have slid by more than 50p, losing almost a fifth of their value (-18.4%). So has this FTSE 100 stock dropped into Mr Market’s bargain bin, or is it a classic value trap?

NatWest stock looks fairly cheap to me

For me, the NatWest brand will forever be tarnished due to its ownership by RBS, the worst-managed bank in Britain. During the global financial crisis, RBS came to the very brink of collapse before being bailed out by British taxpayers to the tune of £45.5bn. Crikey.

That said, NatWest is run along much more conservative lines nowadays — and it finally ditched the RBS brand in July 2020. At present, the group is valued at £22.6bn, making it the smallest of the UK’s ‘Big Four’ banks. But after recent falls, NatWest shares look inexpensive to me.

At the current NatWest share price of 232.1p, this stock trades on a price-to-earnings ratio of 9.4. This translates to an earnings yield of 10.6% — almost 1.4 times the FTSE 100’s yield of below 7.7%.

What’s more, NatWest’s dividend yield of 5.1% a year is a full percentage point above the Footsie’s cash yield. In addition, this yield is covered 2.1 times by earnings, which suggests to me that it is both solid and has plenty of room to grow.

Dark clouds are gathering

Now for the bad news for British banks. Consumer confidence is being shattered by soaring inflation, sky-high energy and fuel bills, rising interest rates, and the growing risk of a deep recession. All of this — plus a weakening property market — spells bad news for large lenders in 2022-23.

Currently, I don’t own NatWest shares and I’ve decided not to buy for now. I do like the look of this business and its share price, but my family portfolio already has exposure to two other major British banks. So, despite NatWest’s attractive fundamentals, I won’t buy shares in the bank in November. Instead, I’ll look for good value in another sector of the FTSE 100!

What a difference three months make. On 29 July 2022, NatWest released its half-year results, and the FTSE 100 member’s share price moved about 8%: but it went up, not down. As always, July’s interim results started with a commentary from the group’s chief executive. The opening paragraph began with “NatWest Group delivered a strong performance…“. The second paragraph opened with, “We know that continued increases in the cost of living are impacting people, families and businesses…“.

Today’s commentary started like this: “In a challenging environment, NatWest Group continues to deliver a strong financial performance”. The second paragraph began with, “At a time of increased economic uncertainty, we are acutely aware of the challenges that people, families and businesses are facing…“. 

Gains and losses

The tone of this quarter’s results is noticeably gloomier. It is difficult to read the good news in the report without immediately encountering the bad bits. The bank’s pre-tax operating profits of $1.1bn are some 20% higher than for the same period last year. But, they fell short of the $1.2bn analysts were expecting.

This quarter’s net interest margin–the difference between what NatWest lends and borrows at–of 2.72% was 26 basis points higher than in the first quarter of this year. But, other operating expenses were 1.8% higher in the year to date.

The £247m impairment charge that hit this quarter’s income statement has drawn much attention. This charge estimates future losses from defaults and missed payments on loans the bank has made. Last year it was not a charge but a gain for the same period. There can be no doubt that NatWest management is expecting more challenging times.

And those times are seen to be tougher than analysts expected with their estimated charge of £173m. The difference between the bank and analyst estimates goes a long way to explaining why the bank missed the pre-tax profit estimate.

NatWest share price fall

Investors must have known about the UK’s cost-of-living crisis ahead of the report. They must have been aware of the potential for NatWest customers to default or miss payments on loans due to that and the rise in interest rates. NatWest’s interim report was full of references to this potential issue. But it would seem that this quarter’s report has suggested to investors that the bank is now expecting to run into problems. NatWest said it is “…not yet seeing signs of heightened financial distress…” from its customers. But, surely it expects it, given the size of that loan loss provision.

That’s probably why the NatWest share price has fallen: Investors expect material impacts on the bank’s performance in the coming quarters. If that comes to pass, then some solace might be found in the idea that a windfall tax on banks’ profits — an option that Rishi Sunak has said is still on the table — is less likely if those profits are being eaten away by such things as loan loss provisions in a period of tougher economic times for lenders.

With centuries of experience, these banks have been crucial in developing the British economy as you know it today. They have funded businesses throughout the country and have helped elevate the economy. 

As a result, the top UK banking shares today offer strong dividends and steady growth. And over the years they have become the pillars of the investment community in the country.

We’ll break down what beginner investors need to know to explore and invest in the thriving UK finance sector, by looking at the top five banking shares in terms of market share. 

What are bank shares?

Bank shares are publicly listed companies that provide a broad range of financial services to the public and businesses alike. 

Common operations include maintaining accounts and providing loans, mortgages, and asset management services. Banking groups also provide secure transactional pathways that enable account holders to pay and receive money via instruments like credit cards, debit cards, and digital transfers.

Top UK banking shares

Here are some of the top UK banking shares in order of highest market cap.

1.  HSBC Holdings 

The European banking giant, established in Hong Kong in 1865, has grown to become a huge force in the field. Currently, HSBC Holdings (LSE:HSBA) has the highest total assets of all major European banks, worth over $15trn. And the banking firm now has a new area of focus and a new strategy that looks exciting on paper. 

In the midst of the pandemic in 2021, HSBC announced that it was switching focus to the growing Asian markets while slowly withdrawing from Britain and the US. This led to the banker cutting over 35,000 jobs and acquiring smaller banking groups in countries like Singapore and India, further cementing its Asia-first strategy. 

And the move as already proven to be a successful switch for the banker. In July 2022, HSBC announced that it had become the first foreign lender to open a Communist Party of China committee in its Chinese investment banking subsidiary. While this move has been criticised by regulators in the UK, investors see this as a strong move that could open up a vast, economically affluent market.

As of July 2022, HSBC shares have regularly outperformed the FTSE 100 index. While this is not an indicator of future returns, 2022 has been a very turbulent economic period. This banking share’s ability to navigate choppy waters is impressive.

2.  Banco Santander SA

Banco Santander (LSE:BNC) or Santander Bank as it is known in the UK, is the 16th largest multinational bank in the world. It is one of the biggest bankers listed in the LSE today and has a huge presence in South America. It is also expanding slowly into the emerging Asian market as well. 

Santander’s priority over the last few years has been customer acquisition. Its campaign has proven successful, adding 32m new customers since 2015 and taking its total customer base to 153m. During this growth, the business has been maintaining a steady operating income that hasn’t dipped below €20bn since 2008.

And profits have been increasing too. In fact, 2021 was the most profitable year for the bank in its history, bringing in €15.3bn, thanks to strong business momentum across most regions. The company is also seeing loan approval rates go up in cash-rich regions like Europe and the US. The repaying ability of the average citizen in those regions is much higher than in Santander’s developing markets, which is a sign that recurring revenue growth could be high over the coming years. 

Santander shares might be lagging behind some of the other companies on this list when it comes to digital banking services. But it is making good strides and is actively developing a range of digital banking services. In 2021, 54% of its total sales were through its digital channels.

3.  Lloyds Banking Group 

As a mainstay of the British finance sector, Lloyds Banking Group (LSE:LLOY) is the most recognised bank in the UK. Since its operations are highly focused around Britain, Lloyds shares and its performance are seen as a barometer for the larger UK economy.

The cash-rich banker is looking to diversify its assets. Since a large majority of its income is from mortgage lending, the banker decided to enter the real estate market in full force in 2021. A partnership with top UK real estate developer Barratt Developments will see the bank acquire 50,000 plots by 2030, making it a top 10 developer in the region. 

Diversifying assets is crucial for UK banking stocks to avoid the pitfalls of recessions. The only way banks can offset losses from payment defaults is to invest their excess cash effectively. And despite falling housing prices, this move may open up a whole new market for Lloyds to explore over the next decade. Offering prepackaged loans for houses developed by Lloyds could become a unique sales pitch that could draw young buyers.

4.  Barclays

This universal British banker offers banking and investment solutions across the globe. With a strong presence in the US as well as top economies in Europe, Barclays (LSE:BARC) is one of the most recognised names in the world of finance. 

The firm has made between £5bn and £8bn a year since 2018 on credit card payments alone. It also has a thriving business banking division and is a highly digitised business offering cutting-edge mobile banking solutions. Its banking app is one of the most downloaded in the western world with 10m users (as of 2021) and 3bn+ logins.

This FTSE 100 bank share’s poor performance across 2022, given the economic turbulence in the UK, has made its valuation incredibly attractive. It is currently one of the cheapest blue-chip banking stocks listed on the LSE. But investors and the board alike are sure that Barclays, like most top banking shares, will make a strong comeback as things get better.

5.  Natwest Group 

The final banking share on our list is no slouch. Natwest Group (LSE:NWG) is the largest business banker in the country. Supporting over 19m customers in the UK, Natwest aims to provide cutting-edge banking solutions and also has lofty environmental sustainability goals.

In fact, Natwest announced its Green Mortgage product, with £728m of lending allocated to champion green businesses. The bank supports several businesses that are helping other businesses meet their environmental goals as well. Natwest’s digital offerings are popular too. Over 60% of its retail current account holders interact with the bank only through digital mediums. 

On the business side, 2021 was a great year for Natwest. Total lending values grew by £7.8bn, primarily driven by mortgages. While this UK share has struggled like every other financial institution in 2022, over the last 12 months of trading, Natwest shares have risen over 15%. This places it second in terms of returns compared to all other banks on this list (behind HSBC). 

This shows investor confidence when the FTSE 100 index has been struggling for stability. And looking at Natwest’s historic dividend growth and the average yield of 4.5% across 2022, it is clear why investors favour this banking share over others.

Why are UK bank shares falling in 2022?

In 2022, markets worldwide have witnessed huge collapses. It is clear now that the economic impact of the pandemic will be drawn out. And the UK is in a particularly vulnerable state right now due to rising geopolitical tensions in Europe and the ever-changing energy lobby. 

Rising costs have raised inflation throughout the year and are expected to outstrip 11% by the end of 2022. As a result, banking shares have become a hot topic of debate right now as the Bank of England mulls further interest rate hikes. While some big lenders like Lloyds stand to benefit from higher interest payments in the short term, investors are still concerned about the spending power of the average citizen if the UK enters a recession. 

Forcing consumers to save every penny creates a bad business environment, especially for banks. Most banks make money for every transaction and thus stand to make less in a recession. Historically, a period of poor economic growth is marked by banking stocks falling fast. Also, in a recession, payment defaults could increase, which is a liability. 

Will banking shares recover?

The data shows that finance shares are the first ones to recover from a crash because banks tend to invest right, be cash-rich, and use governmental support to recover losses quickly. 

All the banking shares discussed on this list are considered blue-chip finance stocks with huge cash reserves and assets. And even in an economic downturn, banking services will be essential. Even after the crash in 2020, the banking stocks on this list have shown strong signs of recovery and are steadily posting better results every quarter.

If you are looking to add UK banking shares to your portfolio as a growth option or for passive income, these bankers are a great starting point. By understanding how these top banking shares are different, new investors can understand the fundamentals better and know what to expect from an investment in banking shares in the UK. 

But the FTSE 250, which tends to be a better reflection of the health of the UK economy, is down 10% over the past month. And while my portfolio has taken a hit, it’s also a good time for me to look at buying more of those stocks that I believe in the most while they’re trading at knockdown prices.

So here are two stocks that have taken a battering in recent weeks that I’m looking to buy.

NatWest Group

NatWest Group (LSE:NWG) had been one of the shining lights of my portfolio. But the stock has fallen 14% over the week and is currently down 8.5% over the past 12 months.

The stock plummeted after the government’s mini-budget caused shockwaves through the banking sector. Many companies withdrew a big slice of their lending products from the market with the Bank of England (BoE) forced to intervene.

Things worsened when it was reported that the government was considering changing the BoE’s money-printing programme to avert a £10bn payout to banks.

However, there is one big positive. And that’s the fact interest rates are rising and might even hit 6% next year. A 6% base rate is really going to slow the appetite for new loans — that’s what it’s supposed to do. But it will also have a phenomenal impact on revenue.

Net interest margins (NIMs) have risen considerably this year and it’s already had an impact on banks’ revenues. But with interest rates potentially doubling over the next six months, banks should become vastly more profitable.

I appreciate that inflation and recession forecasts are not good for credit quality but, because of expanding margins, I’d buy more NatWest shares today.

WH Smith

WH Smith (LSE:SMWH) is down 14% over the week and 31% over the year. Perhaps, more interestingly, the company is down 40% over three years. But the company recently said group revenue is coming in “comfortably in excess” of pre-Covid levels.

WH Smith said that travel revenues have surged to 129% of 2019’s pre-Covid level in the 26 weeks ended August 27, and group revenues hit 112% of 2019’s result over the same period. But high street revenues were still lagging, it said.

Moreover, brokerage Berenberg recently highlighted the company’s defensive growth profile and limited exposure to cost inflation, adding that the retailer’s North American expansion story can drive shareholder returns for years to come.

In addition to this, I’d also suggest that demand for travel is pretty robust right now, despite the macroeconomic environment, while airport footfall and airline seat capacities are improving. The company’s outlets are predominantly positioned at train, bus and airport terminals.

Trading just below 1,200p, I’d add more WH Smith stock to my portfolio.

[Just beginning your investing journey? Check out our guide on how to start investing in the UK.]

Safestore Holdings

What it does: Safestore is a leading self-storage provider operating throughout the UK and Europe via a network of 179 locations.

By Zaven Boyrazian. Safestore Holdings (LSE:SAFE) is the UK’s largest provider of self-storage solutions, with 179 facilities around the UK and Europe. In total, the group has just over 7.6 million square feet of leasing space at an 84.3% occupancy rate as of July 2022.

While self-storage is hardly the most exciting sector, it provides a critical service that’s growing in demand and generally resilient to economic shifts.

So far this year, Safestore’s revenue has grown by a solid 15.6% overall and 12.8% on a like-for-like basis. Management has also been exercising a bit of pricing power to bolster its average storage rate by 9.1% to £28.59 per square foot. And with only a handful of fixed operating costs, net profit margins stand at an impressive 42.7%

Despite delivering consistently impressive results, shares currently trade at a dirt-cheap P/E ratio of just 3.9. Pairing this with a 3.1% dividend yield makes me believe a bargain income opportunity has emerged for my stocks and shares portfolio.

Zaven Boyrazian does not own shares in Safestore Holdings.

NatWest

What it does: NatWest is a banking firm based in the UK. It specialises in a number of products, including personal and commercial banking.

By Andrew Woods. For 2021, NatWest (LSE:NWG) paid a dividend of 10.5p per share. At the time of writing, this payment equates to a dividend yield of around 4.66%. Although that’s not the largest yield on the market, I still consider it to be solid.

The company has been benefiting from a trend of rising interest rates. Rates have risen to 2.25% in the UK and may well climb higher as central banks seek to bring inflation under control.

Higher rates basically mean that banks can charge more for borrowing services. However, since they make loans and mortgages more expensive, some customers may be put off taking on more debt amid the cost-of-living crisis.

Regardless, the firm posted an operating pre-tax profit of £2.6bn for the six months to 30 June. This was up from £2.3bn for the same period in 2021. For now, at least, the bank appears to be in a strong position and my income favourite at the moment.

Andrew Woods has no position in NatWest.

Endeavour Mining

What it does: The company owns and operates gold mines across Africa. It makes money by selling the gold it extracts.

By Stephen Wright. Shares in Endeavour Mining (LSE:EDV) just hit a price that I find it impossible to ignore them at. That’s why they’re my top British income stock for October.

As a gold mining company, Endeavour’s profitability is tied closely to the price of gold. The higher the gold price, the more money the business makes.

Recently, the price of gold has been coming down, falling from $1,756 per ounce to $1,643 per ounce. And the stock I’m looking at has fallen from £18.09 per share to £15.83.

To me, this looks like a good opportunity to buy shares. Over time, I expect the price of gold to increase and I expect all gold mining companies to benefit.

The reason for focusing on Endeavour specifically, though, is that it has lower costs than its competitors. This gives it an advantage that I think is extremely difficult to replicate.

Stephen Wright does not own shares in Endeavour Mining.

United Utilities Group 

What it does: United Utilities supplies water and wastewater services to 7m households in the North West of England.

By Royston Wild. I think buying classic defensive shares could be a good idea as stock market volatility picks up. One I’m thinking of snapping up in October is United Utilities Group (LSE: UU). 

The outlook for the UK economy is plagued with danger as inflation soars and interest rates rocket. But our essential need for water means that revenues at suppliers like this remain rock-solid.

As a consequence, businesses like United Utilities have the financial clout and the confidence to raise dividends at all times. Indeed, for the years to March 2023 and 2024 City analysts are expecting total payouts of 45.57p and 49.42p per share respectively. 

These are up from last year’s full dividend of 43.5p per share. And they provide healthy yields of 4% and 4.4%.  

I also like United Utilities because a lack of industry competition provides revenues with additional security. Though bear in mind that changes to water UK regulations could have an impact on future earnings.

Royston Wild does not own shares in United Utilities. 

Glencore

What it does: Glencore is the world’s largest commodity trader, known for trading metals that include the likes of zinc, copper, lead, and nickel.

By John Choong. Bucking the trend of the FTSE 100, Glencore (LSE: GLEN) has outperformed the wider index by more than 20%, at the time of writing. Pair that with a decent dividend yield of just under 5%, and the commodity giant certainly looks like a lucrative income stock to buy for my portfolio.

In its latest half-year results, Glencore smashed it out of the park by posting top line and bottom line growth of 43% and 820% respectively. While the outlook for metals is a rather uncertain one given the economic conditions surrounding a global recession, management believes that the reopening of China in the second half of the year could boost its income stream, and dividend as a result, while helping to hedge against declining metal prices.

Nevertheless, it’s worth noting that the miner’s dividend isn’t well covered by current earnings and cash on its balance sheet. So any substantial decline in metal prices and overall demand could significantly hamper the dividend payout. 

John Choong has no position in Glencore.

Smith & Nephew

What it does: Smith & Nephew is a medical technology company that specialises in hip and knee implants and advanced wound management.

By Edward Sheldon, CFA. Smith & Nephew (LSE: SN) shares have fallen in recent months due to challenges associated with supply chains, inflation, and China, and I think the share price fall has created an attractive buying opportunity for long-term investors like myself.

In the near term, the challenges I’ve mentioned above could persist. However, eventually, I expect them to moderate as the world returns to normal after the pandemic. And when they do, sentiment towards the healthcare stock should improve. It’s worth noting that, in many countries, there are large backlogs for joint replacement surgery.

Meanwhile, the long-term growth story here remains attractive. By 2030, one in six people globally will be 60 or over. This is likely to create strong demand for joint replacements.

With the stock currently sporting a P/E ratio that is not much higher than the average FTSE 100 P/E, and offering a dividend yield of about 3%, I think it’s a good time to be buying here.

Edward Sheldon owns shares in Smith & Nephew.

BAE Systems

What it does: BAE Systems is a defense, aerospace and security company.

By Paul Summers. Finding a high-yielding income stock isn’t hard right now. Then again, I think it still pays to be cautious. With a recession already here/on the way, many companies may reduce their cash returns or cut them completely. That’s why my pick is BAE Systems (LSE: BA).

Prompted by the invasion of Ukraine, its shares have been in fine form in 2022. This has reduced the yield to a pretty pedestrian 3.2%. Even so, payouts are likely to be covered twice by expected profit. This arguably makes the £25bn cap a relatively safe play for income hunters.  

At almost 16 times earnings, the shares trade at a premium to their five-year average. Hence, there might be some profit-taking on the horizon. However, I think this is a risk worth taking. BAE boasts a superb record when it comes to consistently increasing its annual payouts. 

Paul Summers has no position in BAE Systems

Flooring

James Halstead (LSE: JHD) makes flooring, for commercial and consumer markets. And over the past few years, earnings have been holding up pretty well and dividends have been climbing steadily.

But the share price has been suffering, falling 20% in the past 12 months. Over five years, though, we’re looking at only a 5% fall, so I suspect there’s been a needed correction along the line there.

Full-year results are due on 3 October, and August’s trading update suggests they should be good. The company described turnover as robust, saying it should be 9%-10% ahead of the previous year.

At the interim stage, James Halstead raised its dividend by 5.9%. The full-year forecast dividend yield stands at 3.8%, which is modest. But it’s been strongly progressive. I’ll be doing my research in October for sure.

Investment management

The investment management business has been under pressure. But Rathbone Brothers (LSE: RAT) hasn’t been suffering too badly, with its share price down 12% over the past 12 months.

We have a Q3 update coming on 19 October, which could be crucial in the current environment. The company has previously described the first half as turbulent, but still achieved net positive inflows.

The forecast dividend would yield around 4.5%, rising to 5% by 2024. That’s obviously very uncertain right now. But Rathbone has a record of regular annual dividend increases stretching back more than a decade. And that’s what I really want to see from a long-term income investment.

Whether we’ll get another annual raise remains to be seen. But the company lifted its interim dividend by 3.7%.

FTSE 100 bank

NatWest Group (LSE: NWG) is the third income stock I’ll be watching out for, with Q3 results due on 28 October.

It might be too early to tell what effect the latest economic turmoil might be having on the bank. But we could get some hint.

Banking shares are generally in the dumps, but NatWest has fallen only a few percent over the past 12 months. The sector weakness puts the shares on a forecast price-to-earnings (P/E) ratio of only around seven, which looks cheap to me.

There’s a forecast dividend yield of close to 5% now, so any news on where that’s likely to go will be welcome. I’m not sure if NatWest is the bank I’d buy, but on the whole it looks like a decent income investment to me.

Buy?

I’d do a lot more research before I’d buy any of these three. But following company news on a monthly basis is an effective way to build a list of candidates over the course of the year.

NatWest Group

Of all the FTSE 100’s banks, NatWest Group (LSE: NWG) offers the greatest yield. For 2022, it boasts a monster 11.8% dividend yield, more than twice that of Lloyds, another popular income stock.

In fact, the business offers excellent all-round value on paper. As well as that huge yield, it trades on a forward price-to-earnings (P/E) ratio of 7.4 times.

Earnings have popped at NatWest in 2022 thanks to rising interest rates. A subsequent rise in what it charged borrowers in the first half of the year powered pre-tax profit 13% higher year on year, to £2.6bn.

The good news is that interest rates are tipped to continue climbing rapidly, too. In fact analysts at ING Bank say they could now soar above 5% in 2023 due to the measures announced in Friday’s ‘mini budget’.

But this is not enough to make me invest in NatWest shares today. Britain’s economy is facing a period of painful contraction in the near term and low growth thereafter. So banking stocks like this face the prospect of soaring bad loans over the next couple of years and weak revenues thereafter.

I’m not averse to buying banking stocks as the global economy toils. However, I’d prefer to invest in ones with exposure to fast-growing economies like Asia-focused HSBC or Standard Chartered. I think they’d be better buys for long-term growth.

Persimmon

On the other side of the coin, Persimmon (LSE: PSN) is a UK high-dividend share which is in danger of losing out from higher interest rates.

Recent action by the Bank of England means that the cost of owning a mortgage is rising sharply. And if those ING projections prove correct and interest rates more than double from current levels of 2.25%, demand for homes could fall sharply.

I’m still backing Persimmon and other homebuilders to continue thriving, however. This is why I actually bought the FTSE 100 share for my own portfolio during the summer.

I’m optimistic because I’m expecting demand for newbuild homes to keep outstripping demand even as rates rise. The government’s decision to cut stamp duty in last week’s mini budget could also help mitigate the impact of higher interest rates.

Most forecasters suggest that Britain needs to create more than 300,000 new homes every year to keep up with demand. Yet with government housing policy still to get off the ground the shortage of new homes is worsening. This suggests to me that property prices should continue rising for some time yet.

Persimmon trades on a forward P/E ratio of 5.5 times. And it carries an enormous 16.3% dividend yield, too. At current prices I believe it remains too cheap to miss.

Right now I’m looking for stocks with certain characteristics. Firstly, I’m want companies that perform well even during downturns — defensive stocks. I’m also looking at companies that make a good proportion of their income in dollars — with the pound weak, this should inflate GBP earnings. And with interest rates rising, I want companies that don’t have debt issues or ones that can benefit from higher rates, such as banks.

So here are three simple stocks I’d buy now with £1,000.

Unilever

Unilever (LSE:ULVR) is a blue-chip, fast-moving consumer goods company with defensive qualities. The London-based firm gets its defensive qualities from the brands that it owns.

Customers tend to continue buying brands that they know even when things might be getting tough economically. Unilever owns many household brands such as Hellmann’s, Marmite, Heinz, Persil, and Lifebuoy. The latter is a soap brand that only appears to be sold outside the West.

And with inflation around 10%, these brands are particularly useful as it allows Unilever to pass costs on to customers. In its H1 results, Unilever said it lifted its prices by 9.8% versus the same period in 2021 and this only resulted in a small fall in sales volumes.

A prolonged recession won’t be good for consumption, but as times get tough, I’d expect Unilever to perform better than its peers. It looks a little expensive with a price-to-earnings (P/E) ratio of 17. But I think it’s worth it. I’ve already added Unilever to my portfolio. It also sells in 190 countries.

Diageo

Drinks maker Diageo (LSE:DGE) also has defensive qualities, selling brands like Johnnie Walker, Guinness, Baileys, and Smirnoff. Moreover, in January, Diageo contended a strong pound had negatively impacted earnings. But that’s certainly not the case anymore with £1 being worth just $1.16 today.

And this is important because the company makes the vast majority of its earnings outside the UK. More than a third of the firm’s sales come from North America — the figure, $6bn, is around double the company’s earnings in Europe.

The last full year was a stellar one, with net sales rising 21.4% to £15.5bn. Recessions are unlikely to be good for alcohol consumption, but I think Diageo, with its strong brands and its dollar earnings, will continue to perform well.

NatWest

I see British banks as a good purchase right now. With interest rates rising, these stocks are making more money than they have done for years. NatWest (LSE:NWG) is a fairly safe choice. It’s still partly owned by the government and is heavily focused on the UK market.

Net interest margins (NIMs) — the difference between the interest income earned and the interest paid out to lenders — were up in the first half report, and they’re likely to increase further. Analysts are anticipating that Bank of England interest rates will get as high as 4% in 2023.

Recessions aren’t good for credit quality, but higher NIMs more than make up for it.

Right now, I’m looking at banks and defensive stocks. And there are several reasons for this. Banks, which are normally reflections on the health of the economy, are poised to surge, in my opinion, on the back of higher interest rates.

Meanwhile, defensive stocks are companies that are likely to see continuous demand, regardless of economic conditions. This often means companies operating in areas like water and utilities, but also branded goods.

So let’s take a look at two stocks I’m buying ahead of what I predict to be a lively autumn for markets, and why.

NatWest

I’m buying British banks because interest rates are rising, and so are net interest margins (NIMs). In fact, interest rates are the highest they have been since 2008. And there’s a chance we could even surpass 2008 levels, according to some analysts.

Near-zero interest rates haven’t been good for banks. But we’re now seeing interest income surge.

NatWest (LSE:NWG) is among my top UK banks. After a stellar Q2, the bank now expects full-year revenues to rise by roughly 25% year on year, to approximately £12.5bn. That’s 6% above consensus expectations.

The growing revenues have been a result of increasing interest margins. Q2 revenues actually exceeded consensus estimates by 8%.

Revenue is likely to increase further in the coming months with the Bank of England (BoE) expected to push interest rates up further. NatWest, like its peers, will even earn more interest on the money it leaves with the BoE.

I appreciate that credit quality will likely fall with a recession forecast, but I believe higher margins will more than make up for it.

The bank has a dividend yield of 4.5%.

Unilever

Unilever (LSE:ULVR) is a blue-chip fast-moving consumer goods company based in the UK. With recession forecasts, I might be forgiven for thinking this isn’t the best stock to buy right now.

But the strength of Unilever lies in the brands it owns and its international reach. It owns many household brands such as Hellmann’s, Marmite, Heinz, Persil, and Lifebuoy — the latter being a soap brand that only appears to be sold in developing nations.

In its recently released first-half results, the company demonstrated its pricing power. Unilever said it lifted its prices by 9.8% versus the same period of 2021, but only saw a 1.6% contraction in sales volume. As a result, revenue grew 8.1%.

The data highlights Unilever’s ability to pass on rising costs to its customers. It now expects to beat its previous forecast of sales growth between 4.5% and 6.5% for 2022.

And as the pound increasingly weakens, the firm, which sells in 190 countries, will also see its GBP income inflated.

Finally, I appreciate that a long and drawn-out recession won’t be good for consumption, regardless of the products in question, but Unilever is among those best placed to deal with it. That’s why I’m buying this stock. It’s also offering a 3.8% yield.

NatWest shares look cheap to me

The most recent consensus forecasts for NatWest’s earnings per share (EPS) in 2022 and 2023 are 32.1p and 38.3p per share, respectively. NatWest shares are currently trading at a forward price-to-earnings ratio (P/E) of 7.9 (2022) or 6.6 (2023), based on a share price of 252p at the time of writing. Given the FTSE 100 average forward P/E is 13.9, NatWest shares look like good value compared to the wider market.

Compared to its peers in the whole financial sector — which has an average P/E of 8.6 — NatWest again looks cheap. I think NatWest is a cheap FTSE 100 stock with above-average benefits to me as a shareholder in terms of its dividend yield and earnings growth prospects.

An attractive dividend

NatWest is forecasted to pay a dividend of 20.9p per share in 2022 and 14p per share in 2023. At 252p per share, that’s a forecasted 2022 dividend yield of 8.1% and 5.6% for 2023. NatWest is a FTSE 100 index stock with a dividend yield comfortably higher than the forecasted index average yield of 3.63%. Also, the banking services industry group’s average dividend yield is 4.39%, which NatWest again beats.

NatWest has already committed to paying an interim dividend of 3.5p per share. A special dividend of 16.8p was approved by shareholders last Thursday, along with a share consolidation. All that remains to be seen is what the final dividend looks like. It won’t have to be much to hit that 8.1% forecasted yield.

So, I have convinced myself that I have found a FTSE 100 stock that looks cheap and has an attractive dividend. But how safe are those dividends? To answer that question, I will need to look at NatWest’s earnings and growth potential.

A FTSE 100 stock for my portfolio

The markets are pricing in rates of 4% by May next year. That should be good for NatWest. In its half-year report, released at the end of July, the bank’s net interest margin — the difference between what it pays depositors and what it lends at — was up, which increased its income. Natwest’s lending activity was also solid, driven partly by strong mortgage growth.

NatWest’s dividends this year will be covered in full by earnings. Next year the forecast is for earnings to grow from 32.1p to 38.3p per share. That should cover dividends by around 2.5 times, which is excellent.

NatWest is doing well with rising rates. But inflation is driving those rate rises. People are starting to struggle with the cost of living in the UK. If NatWest’s customers stop lending and loan defaults start to rise, this will hurt the bank’s bottom line. There is a real possibility this could happen, which would probably cause the share price to slide and perhaps compromise the dividend. However, on balance, I am happy to take risks for the potential rewards with this FTSE 100 stock.