Should You Sell Lloyds Banking Group PLC And Buy Schroders plc?

Asset manager Schroders (LSE: SDR) may be a FTSE 100 company, but it’s hardly a household name. In contrast, I doubt if there’s a single person in the country who hasn’t heard of Lloyds (LSE: LLOY).

Of course, when it comes to investing, it doesn’t necessarily follow that the best returns come from the best-known companies. I’m looking today at whether Schroders could be a better home for your hard-earned than Lloyds.

The fortunes of these two financial firms in recent years couldn’t have been more different.

Before the financial crisis, Lloyds was a high-yield dividend hero. The crisis and the government bailout did for the dividend. Shareholders saw no cash after 1 October 2008, until Lloyds resumed payments on 19 May this year with a symbolic 0.75p payout.

In contrast, Schroders offered a modest yield before the financial crisis, but it’s strong balance sheet saw it through the dark days. In 2009, the company held the payout at the same level as 2008, but it quickly began to rise again thereafter. The readout of subsequent annual increases runs: 19%, 5%, 10%, 35% and 34%.

During a period in which Lloyds has paid a dividend of 0.75p, Schroders has paid a total of 307p. If you’d bought £1,000 of Schroders’ non-voting class of shares (LSE: SDRC) at the lows in the autumn of 2008, you’d have received about £570 in dividends to date. Meanwhile, the share price has risen 350%. Lloyds shares are up 275% from their lowest point.

That’s the past, but what of the future? Could it be a good idea to sell Lloyds and buy high-performing Schroders, or can the Black Horse outgallop Schroders going forward?

Schroders’ business is certainly continuing to generate impressive horsepower, as half-year results released today demonstrate. The company saw a net inflow of cash into its funds of £8.8bn during the period. Pre-tax profit was up 24% (17% on an underlying basis), underlying earnings per share (EPS) rose 15%, and shareholders have been given another tasty increase in the dividend, with the Board hiking the interim payout by 21%.

Ahead of today’s results, the analyst consensus was for full-year EPS to increase by 7% and the dividend by 9%, so we will doubtless see some upgrades to forecasts after the strong first-half performance — although, the company itself has cautioned that likely high market volatility due to continuing uncertainty in the eurozone and China, and the prospect of interest rate rises in the US, may impact demand in the second half, particularly from retail investors.

As things stand, based on the price of the non-voting shares at 2,435p, Schroders trades on a current-year forecast price-to-earnings (P/E) ratio of 13.6, falling to 12.4 for 2016. The corresponding dividend yield readouts are 3.5% and 3.9%. The P/E and yield put Schroders on the value side of the FTSE 100 as a whole, and, just to reiterate, this is before any analyst upgrades.

How does Lloyds’ valuation compare? Based on a share price of 86p, the P/E is 10.6 for both this year and next, as analyst aren’t forecasting year-on-year earnings growth from 2015 to 2016. However, dividend growth is on the cards, because Lloyds is expected to increase the proportion of earnings it pays out as dividends in the coming years. Analyst consensus forecasts give a yield of 3.2% this year, rising to 4.8% for 2016.

Lloyds, of course, is just starting to get profits rolling again, after its long recovery from the financial crisis. Today’s news of the £827m sale of its portfolio of Irish commercial loans — leaving it minimal remaining exposure to commercial assets in Ireland — is another of Lloyds’ final steps in deleveraging its balance sheet and creating a low-risk, UK-focused bank. The company releases half-year results tomorrow, which I expect to show a continuing healthy improvement in the business.

Schroders is certainly a class act, and its P/E and yield suggest it still offers value. However, I’m not convinced there’s a strong case to sell Lloyds and buy Schroders at this stage. That’s because Lloyds should be able to start clicking through the profit-making gears in the coming years. And, with its P/E of just 10.6 and prospective yield of 4.8% for 2016, I would say there’s potential for Lloyds’ shares to re-rate significantly higher.

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G A Chester has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.