COMMENT
Britain's Best Big Bank

By David Kuo (TMFDragon)
July 18, 2005

We all know what a bank is. But in case you don't, here's a formal definition from Encyclopaedia Britannica:

A bank is an institution that deals in money and its substitutes, and provides other financial services. Banks accept deposits and make loans, and derive a profit from the difference in the interest rates paid and charged, respectively. Some banks also have the power to create money.

Phew! There we have it. But given that all banks do roughly the same thing, what makes one bank a better long-term investment than another?

In my view, it boils down to four things. And here are how Britain's "Big Four" banks, HSBC (LSE: HSBA), Royal Bank of Scotland (LSE: RBS), Barclays (LSE: BARC) and Lloyds TSB (LSE: LLOY) measure up.

Geographic Spread

To qualify as a good long-term investment, a bank should have operations in a wide number of countries. This should allow it to offset poor performance in one place with better results elsewhere. HSBC is undoubtedly the most internationally diverse of the three banks, so I'm going to give it top marks. Meanwhile, RBoS generates around 30% of its profits outside of the UK, while Lloyds TSB and Barclays are the least internationally diverse. That said Barclays is moving in the right direction with its expansion into South Africa, but Lloyds TSB has been scaling back its international operations to focus on the UK market.

HSBC 9/10
RBoS 7/10
Barclays 6/10
Lloyds TSB - 5/10

Valuation

In terms of valuation, RBoS is the cheapest on a P/E of 9, with Barclays and Lloyds TSB close behind at 10 times earnings. However, HSBC has considerable exposure to less mature, and therefore riskier, economies such as China, Mexico, and Brazil. This means that it sits on a higher P/E than the other two. So in my view, it's a decisive win for RBoS on valuation grounds.

HSBC 7/10
RBoS 9/10
Barclays 8/10
Lloyds TSB - 8/10

Earnings Growth

Historically, RBoS has been the fastest growing bank of the four. Since 2000, profits have more than doubled thanks to its acquisition of NatWest. However, future profit growth could be more mundane. Over the next two years, profits are expected to rise around 10% a year, similar to HSBC. Slightly slower growth of 8% is anticipated at Barclays, but profits at Lloyds TSB are only expected to grow at half this rate. So it's a tie for first place between RBoS and HSBC.

HSBC 8/10
RBoS 8 /10
Barclays 7/10
Lloyds TSB - 5/10

Dividend Yield

Lloyds TSB is the highest yielding of the four banks by a long chalk at 6.9%. It pays out almost three-quarters of its profits as dividends because it is does not need the cash for growth. Barclays, which pays out half its profits as dividends, and yields 4.9% is a distant second. HSBC also pays out around half its profits to shareholders, but its yield is slightly lower at 4.6%. By comparison, RBoS only pays out a third of its profits as dividends. This is largely because it's still been paying for is NatWest acquisition. Mind you, yields at RBoS should improve gradually, but for now it gets the wooden spoon.

HSBC 7/10
RBoS 6/10
Barclays 8/10
Lloyds TSB - 10/10

Final score

And this is the moment that we've been waiting for. Totting up the four categories we get

HSBC 31
RBoS 30
Barclays 29
Lloyds TSB - 28

So based on my measures, I declare HSBC the winner by a slight margin. However, if truth be known, any of the four banks should make good long-term investments. And as part of my balanced portfolio, I always try to ensure that I own shares in at least one bank, and currently it's Barclays. However, it could easily have been either HSBC, RBoS or Lloyds TSB!

David owns shares in Barclays.

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