The performance of shares in Hargreaves Lansdown (LSE: HL) over the last five years has been stunning with investors in the financial services company recording a capital gain of 157%. Clearly this is well ahead of the FTSE 100’s 6% rise in the same time period. Notably, it’s also superior to the performance of the vast majority of Hargreaves Lansdown’s sector peers.
But looking ahead, Hargreaves Lansdown may be unable to repeat such a strong level of outperformance. Certainly, its outlook as a business remains highly encouraging with its bottom line being due to rise by 18% in the current year. However, with its shares trading on a price-to-earnings (P/E) ratio of 37.6, they appear to fully reflect its upbeat potential.
Furthermore, Hargreaves Lansdown lacks appeal as an income play too. For example, it yields just 2.5% and with dividends representing 94% of profit, there seems to be limited scope for an increase in shareholder payouts over the medium term.
Of course, the future of other financial services companies is also uncertain. Notably, challenger banks such as Shawbrook (LSE: SHAW) face the threat of being forced to hold higher amounts of capital in case of worsening economic performance. This could hurt their profitability and as such, challenger banks have seen their valuations come under pressure in recent months. Shawbrook’s shares have been relatively volatile and have fallen by 6% in the last six months.
Despite this, Shawbrook’s valuation appears to adequately price-in the uncertainty. It trades on a P/E ratio of just 11 and with its net profit expected to rise by 30% this year, it equates to a price-to-earnings growth (PEG) ratio of only 0.4. And with dividends representing only 12% of net profit, there’s scope for Shawbrook’s 1.1% yield to rapidly rise in 2017 and beyond.
More falls ahead
Meanwhile, HSBC (LSE: HSBA) continues to be hurt by doubts surrounding the Chinese growth story with today’s share price correction in Shanghai causing investor sentiment in HSBC to decline. Due to this, HSBC is down by 3.3% already in 2016, which puts it on a P/E ratio of just 10.3. This indicates that there’s upward rerating potential, although in the short run a further fall in its share price seems relatively likely.
Clearly, HSBC’s cost base is a key area of focus for the bank over the medium-to-long term with it appearing to be inefficient compared to a number of its rivals. With a cost-cutting programme having been started, HSBC’s cost-to-income ratio could fall and this may have a positive impact on investor sentiment.
While interest rates are set to rise this year, HSBC’s yield of 6.5% is still likely to hold tremendous appeal. That’s especially the case when dividends are covered 1.5 times by profit and their growth rate is likely to beat inflation over the medium-to-long term. Therefore, while HSBC underperformed the FTSE 100 by 7% last year, it has the potential to beat the wider index in 2016 and beyond – particularly on a total return basis.
