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Why HSBC Holdings plc isn’t the only banking stock I’d buy today

One of the characteristics of the stock market is its ability to price in future events. This is why when HSBC Holdings (LSE: HSBA) announced an 11% increase in adjusted pre-tax profit to $20.99bn last week, the shares fell by nearly 5%.

It turns out that analysts had been expecting slightly higher profits. City watchers also suggested that the bank’s focus on Asia — which now accounts for 75% of profit — meant that HSBC might benefit less from rising US interest rates.

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In my view, investors don’t need to worry about this kind of minor short-term detail. This £146bn banking group is a big picture stock — and from what I can see, the picture is one that I’d like to buy.

A brighter view

Newly-retired chief executive Stuart Gulliver spent most of his eight-year term of office fixing problems at the bank. He’s settled multi-billion dollar misconduct issues, sold troublesome operations and cut costs.

The scale of these changes is impressive. The bank’s annual running costs are now $6.1bn lower than in 2015. Its risk-weighted assets have fallen by $338bn over the same period. I think it’s best to view this £146bn group as a supertanker — it’s hard to change direction, but once it starts moving, it carries a lot of momentum.

Most analysts agree that the business is now nicely positioned for a return to growth, just as interest rates finally start to rise. So what can investors look forward to?

Profits + income

Broker forecasts for 2018 and 2019 suggest that earnings will grow at around 5% each year. The dividend — unchanged at $0.51 per share since 2016 — could also start rising. Shareholder returns may be boosted by further share buybacks, which have been promised “when appropriate”.

With the stock trading on a forecast P/E of 14 and offering a 5.1% yield, I’d rate HSBC as a dividend buy.

Better for dividend growth?

FTSE 250 merchant banking group Close Brothers Group (LSE: CBG) hasn’t featured in the news very much in recent years. That’s because it’s carried on banking profitably and avoided the kind of bad publicity that’s dogged the big banks.

Revenue has risen from £655.3m to £819.6m since 2014, while profits have climbed from £149.8m to £191.2m over the same period.

Long-term shareholders have been rewarded with reliable dividend growth. Impressively, Close Brothers didn’t cut its dividend during the financial crisis. The payout was merely frozen from 2008 until 2010 before growth resumed.

What could go wrong?

Although this group also has stockbroking and asset management divisions, the vast majority of profit comes from lending. In 2016/17, the biggest driver of profit growth was property finance. Car finance is another area where the group is quite heavily involved.

A UK recession could cause a sharp rise in impairments. However, the firm claims to “prioritise our credit quality and margin”. Given its track record over the last decade, I’m inclined to trust management.

These shares currently trade on a forecast P/E of 12 with an expected yield of 4%. If you’re looking for a UK-focused financial stock, I believe Close Brothers deserves a place on your short list.

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A £10,000 investment in Close Brothers in February 2012 would be worth about £20,000 today, plus dividends. Gains such as these can transform your investment profits, helping you to beat the market.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended HSBC Holdings. 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.