Which is the better bank buy right now: Lloyds shares or HSBC?

HSBC pays a much higher yield than Lloyds shares, has much more value left in its share price, and doesn’t have the ‘penny share’ risk of its competitor.

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I recently sold my Lloyds (LSE: LLOY) shares and used part of the proceeds to buy HSBC (LSE: HSBA) stock.

There were four key reasons for this and coming up to the end of Q2, I checked how they stack up now.

Big difference in price volatility risk

Lloyds trades too much like a ‘penny share’ for my liking. Strictly speaking, it is not one, as although it is priced at less than £1, its market capitalisation is huge.

Nonetheless, at just 55p a share, every penny it moves represents nearly 2% of its value.

By sharp contrast, HSBC trades at £6.83 a share currently, so each penny movement is just 0.1% of its value.

This is one category win for HSBC, in my view.

Major valuation gap

This becomes even more important in the context of how much value is left in each’s shares. The closer they are to their fair value, the more chance there is of a significant price reversal.

Lloyds presently trades on the key price-to-earnings (P/E) share valuation measurement at 7.4. This is overvalued against the UK peer group average of 7.1

HSBC trades exactly at the average, so looks fairly valued on this measure.

However, both shares are undervalued against the 7.8 P/E average of their European peer group.

Using a discounted cash flow analysis, Lloyds shares are currently around 14% undervalued overall. On the same basis, HSBC shares are about 54% undervalued.

This implies a fair value for Lloyds shares of 64p, and for HSBC of £14.72.

This does not guarantee that either will achieve those levels. However, it confirms to me that much more value is to be found in HSBC shares.

Another win for it over Lloyds, I think.

Similar business outlook

A key risk for both banks is 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.

An added risk for Lloyds is legal action for mis-selling car loans through its Black Horse insurance operation.

Consensus analysts’ forecasts are that Lloyds revenue will grow at 3.2% a year to end-2026. Over the same period, HSBC’s revenue is expected to rise by 3.5% a year.

There is not sufficient difference to separate the two here, in my view, so the category is drawn.

Huge difference in dividend payouts

Lloyds currently yields 5%, and HSBC 7%. The difference over time in dividends from the two rates is enormous.

£10,000 invested in Lloyds 5%-yielding shares — with the dividends reinvested — would make an extra £34,677 after 30 years.

On the same provisos, HSBC would give me an additional £71,165!

Another major win for HSBC, in my view, making three out of four, with one tied.

Consequently, if I had not already sold Lloyds stock and bought HSBC’s, I would do it right now.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

HSBC Holdings is an advertising partner of The Ascent, a Motley Fool company. Simon Watkins has positions in HSBC Holdings. The Motley Fool UK has recommended HSBC Holdings and Lloyds Banking Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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