I sold Lloyds (LSE: LLOY) shares recently and then bought HSBC (LSE: HSBA) stock for two key reasons.
First, Lloyds trades too much like a ‘penny share’ for my liking. Strictly speaking, it isn’t one, as although it’s priced at less than £1, its market capitalisation is big.
But at just 53p a share, every penny it moves is nearly 2% of the stock’s value. With £10,000 in the shares, I’d lose £200 for every penny loss! If it moved 10p I’d lose £2,000!
Of course, the reverse applies to possible gains made, and this might suit a younger investor. But I’m over 50 now and frankly, I can do without the excitement.
By comparison, HSBC’s current price of £6.44 looks reassuringly solid to me.
UK financial sector looks undervalued
That said, Lloyds may be a good buy over a much longer period, in my view. Ever since the 2016 Brexit decision, many UK financial stocks appear to have been unduly marked down.
Lloyds itself currently trades on the key price-to-earnings (P/E) measurement of stock valuation at just 6.8. HSBC is slightly cheaper at 6.7.
But both are much cheaper than the 7.9 average of their European peers.
Even Credit Bank of Moscow trades at a P/E of 6.3. It rates just 12th by assets in Russia’s banking hierarchy and was placed under international sanctions on 24 February 2022!
Overall, discounted cash flow analysis reveals Lloyds shares to be around 54% undervalued against their peers, and HSBC’s 55% undervalued.
This implies a fair value for Lloyds stock of £1.15, and for HSBC’s of £14.31, although this doesn’t mean either will reach those levels.
Risks on the horizon
FTSE 100 history also shows that the longer the timespan, the more likely it is that fundamentally sound stocks will prosper.
A longer timeframe also allows for the flattening out of any shorter-term shocks seen in a stock or the wider market.
A current risk in Lloyds, for example, is legal action for mis-selling car loans through its Black Horse insurance operation.
And HSBC recently put aside $3.4bn for risk exposure to China.
Both banks also face the prospect of declining net interest margins (NIMs) as UK inflation and interest rates fall.
The NIM is the difference between the interest a bank receives on loans and the rate it pays for deposits.
Again, though, HSBC has a slight advantage over Lloyds here. Analysts’ expectations are for Lloyds revenue to grow at 2.2% a year to end-2026. Over the same period, HSBC revenue is expected to rise by 3.5% a year.
The other big difference
The second key reason why I sold Lloyds shares and bought HSBC’s is the big difference in dividend returns.
Lloyds has a decent yield of 5.2%, against the FTSE 100 average of 3.8%. But HSBC has one that is 2.3% higher – at 7.5%.
If these yields stayed the same over the period, the difference in dividends paid me over time would be enormous.
Specifically, £10,000 – with the dividends reinvested – would give me a total of £47,428 after 30 years in Lloyds stock. On the same provisos, HSBC would give me £94,215!
Consequently, if I hadn’t already sold Lloyds stock and bought HSBC’s, I’d do it right now.
