Why I’d Sell HSBC Holdings plc And Buy Admiral Group plc

Over the past three years, the fortunes of Admiral (LSE: ADM) and HSBC (LSE: HSBA) have been very different. 

As HSBC has struggled, Admiral has surged ahead, continuing to capture market share from its rivals and paying hefty dividends to investors. All you need to do is look at the total return figures for the two companies’ shares over the past three years, to see how Admiral has profited as HSBC flounders.

Specifically, during the past three years Admiral’s shares have returned 20.8% per annum including dividends. Over the same period, HSBC’s shares have returned a lacklustre 0.8% per annum, including dividends. 

Bright outlook

It looks as if Admiral’s market-beating performance will continue for the foreseeable future. 

You see, one of Admiral’s greatest achievements is being able to operate successfully in a tough market. The UK motor insurance industry as a whole has been loss-making for 20 of the past 21 years, but despite this, Admiral has managed to capture a huge share of the market and generate billions in profit — most of which has been returned to shareholders. 

The best way to analyse an insurer like Admiral is to take a look at the company’s combined ratio compared to its industry peers. A combined ratio below 100% indicates that the company is making an underwriting profit. During the first half of 2015, Admiral’s combined ratio fell to 82.7%, from 85.7% a year earlier. Peers esure and Direct Line Insurance reported combined ratios of 95.8% and 89.4% respectively. 

Admiral’s strong performance has continued this year as a low number of claims helped the group beat City expectations for the first-half. The company reported earnings per share of 54.8p. Analysts were expecting Admiral to report first-half earnings per share of 47.0p. 

On the other hand, HSBC has struggled to grow since the financial crisis. The bank has been selling off non-core divisions in an attempt to improve its capital position, exit risky or unprofitable markets and reduce costs. 

So far, this drastic weight loss plan has not had the desired effect for the bank. Costs as a percentage of income are still rising, and HSBC’s growth has ground to a halt. So as organic growth has proven to be elusive, HSBC now has to wait until central banks around the world start to hike interest rates.

Indeed, HSBC’s key advantage over its peers is its enormous $300bn surplus of deposits it has over liabilities. These are invested in government bonds, which are yielding very little. However, when interest rates start to rise, returns will improve, jacking up HSBC’s income. 

Income pick

Investors may have to wait for some time before HSBC returns to growth, but Admiral is still pushing ahead. Moreover, Admiral is one of the FTSE 100’s dividend champions. The company has adopted a stance of returning the majority of its net income to investors via dividends.

Admiral has returned a total of £1.1bn to investors via both regular and one-off dividend payouts during the past five years. This cash return works out to be around 90% of Admiral’s net income generated over the period.

City analysts believe Admiral’s dividend payouts will equal a yield of 5.8% this year and 5.9% for 2016. After recent declines, HSBC’s dividend yield has risen to 6.4%. 

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