Banking Wars: Barclays PLC vs Lloyds Banking Group PLC

I was shocked when I read full-year results from Barclays (LSE: BARC) and discovered it decided to slash its 2016 dividend by more than half, to yield less than 2% instead of the 4.4% tipsters had suggested. I was especially surprised as a few days earlier, Lloyds Banking Group (LSE: LLOY) had announced a better-than-expected dividend payout in its final results.

What’s interesting is that, though it dropped by 8% on the day of the results, in a couple of days Barclays’ share price recovered to 174.3p, higher than the pre-results price!

What to do now?

Barclays shareholders will still get the expected 6.5p per share for the year just ended and have time to adjust to the new regime, but should they sell now or hold? The latter! In my opinion Barclays is a strong buy.

The dividend cut is painful short term, but probably for the long-term best. The bank earmarked another £1.45bn to cover PPI misselling costs in the final quarter of 2015, is also separating its UK retail arm from its investment banking division, and is still engaged in longer-term cost-cutting. And it intends to return to decent dividend payments in due course.

Barclays shares are now on a forward P/E of just 7.5 for 2016, dropping to 6.6 based on 2017 forecasts — and with earnings expected to grow, we’re even looking at attractively low PEG ratios of 0.2 and 0.5, respectively. Even with lower dividends expected in the shorter term, how can that not be a screaming bargain?

Dividends on the up

Lloyds pleased the punters by announcing an extra 0.5p special dividend on top of its ordinary dividend of 2.25p per share. On a 73p share price, that’s a total yield of 3.8%, which is pretty good as 2015 was the bank’s first year of paying both interim and final dividends since the crunch ended. And it bodes well for the yields of 5.4% and 6.5% forecast for this year and next.

The PPI scandal hit taken by Lloyds is the biggest of them all, with £16bn having been set aside to cover it. But the bank reckons the £4bn for 2015 should be last instalment.

Lloyds doesn’t have EPS growth like Barclays on the cards for this year and next and the shares are on significantly higher P/E multiples of 9.7 and 9.5, respectively. But those are still significantly below the long-term FTSE 100 average of around 14, and for dividends that blow the FTSE average out of the water, that looks like a steal.

What I also like about Lloyds is that it’s tightly focused as a UK retail bank, echoing the divisional split that Barclays is engaged in, and it has avoided the disconnected, clutching-at-all-straws, banking model of the past.

Which to buy?

The dividend picture at Barclays is less attractive in the shorter term, but that’s reflected in the stock’s lower P/E multiple, which implies that if its dividend recovers to match Lloyds’, the shares could be valued around 40% higher.

On the other hand, that dividend at Lloyds looks hard to resist, even without short-term EPS growth. Overall, my money is (literally) on Lloyds, as it’s closer to its long-term structural aims, so giving more clarity and reduced uncertainty. But if I were looking to invest more cash in the sector, my eye might be on Barclays — I don’t think you can lose with either.

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Alan Oscroft owns shares in Lloyds Banking Group. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.