In the aftermath of the financial crisis, you would never have thought of Barclays (LSE: BARC) (NYSE: BCS.US), Lloyds and Royal Bank of Scotland as dividend investments. In fact nothing would have been further from investors’ minds.
After all, most of the banks were heavily loss-making, and had to conserve as much money as they could to stay solvent.
Growing profitability
Yet today the banks are profitable again, and generating enough cash to be able to pay steadily rising dividends. In particular, Barclays has strong appeal as a dividend investment.
This company is cheap. The P/E ratio is 10.6, falling to 8.8 in 2015. The dividend yield is 2.8%, rising to 3.7%, and the dividend cover is currently 4.4. What’s more, the trajectory is very positive, with profitability set to push ahead over the next few years.
Barclays has three main parts to its business: retail banking, Barclaycard and investment banking. Retail banking is progressing well, benefitting from a recovering economy and a resurgent housing market. Barclaycard is also performing well, buoyed by the improving consumer economy. Barclaycard will be an integral part of the rapid growth in contactless and smartphone payments.
But still some concerns
In contrast, investment banking profits have disappointed, as stock markets and commodity markets have fallen. I am confident that the investment bank will recover eventually, when stock markets resume their upward trend, but this will take several years.
In terms of overall profitability, bad debts are falling, and capital ratios are improving, but the main downside is the fines and legal payments due to PPI, Libor-rigging and exchange rate-rigging. Neil Woodford talked about ‘fine inflation’, and although I am more positive, I think he had a point. Investors need to get a handle on the level of these fines in the next few years.
Foolish summary
Bank shares can be volatile, but I see my holding in Barclays as a long-term play on the recovery of financials. My caveat is that this not an investment where I expect to see overnight results, and the company still faces many headwinds. Nonetheless, there is the prospect of capital growth, combined with a dividend yield which is increasing year-on-year, as Barclays’ confidence grows. That’s why Barclays is my perfect dividend investment.
