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The HSBC share price and 5.5% yield tempts me more than BAE Systems

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The big FTSE 100-listed banks have been attracting contrarian investors for years, but so far the rewards have been mixed. For example, shares in China-focused bank HSBC Holdings (LSE: HSBA) trade just 4% higher than five years ago, and still haven’t fully recovered from their plunge during the financial crisis.

Asia major

If you snapped up HSBC during one of the recent dips you will be happy enough, its stock is up 34% over two years. Also, long-term investors will have generated some juicy dividends, given its current yield of 5.5%, which is covered 1.4 times.

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HSBC recently posted a 4.58% rise in half-year pre-tax profit to $10.7bn, on revenues of $27.3bn. It still faces challenges, with its costs rising 7% to $17.5bn, at a faster pace than its income. The bank has doubled down on Asia, but hopes that this would turbo-charge growth have so far been frustrated, and increases its exposure to a China slowdown. Its return on equity is frustratingly low at just below 9%. 

Bank on it

Yet HSBC remains solid with a common equity tier 1 ratio of 14% and an advances-to-deposits ratio of just 72%, while litigation threats are receding. Bad debts are under control and its private banking arm is doing well. City analysts are pencilling in 51% growth in earnings this year, which looks promising. This should also reduce its price-to-earnings ratio, which currently stands at a toppy 19.4.

The underlying concern is that it is difficult for banks to make fat profits in today’s mature, highly regulated and competitive financial services markets. Let’s not be too gloomy, though. My Foolish colleague Peter Stephens reckons HSBC could help you retire early.

Ready to fly

FTSE 100 engineering giant BAE Systems (LSE: BA) will give you an income stream of 3.5%, covered 1.9 times, but at least the entry price is cheaper, trading at just 14.6 times earnings. This is another FTSE 100 blue-chip whose combination of growth and income could give you financial independence in the longer run.

BAE also boasts a steady flow of work, receiving a hefty £9.7bn of new orders during the first half alone, giving it a comforting £39.7bn backlog. Not bad for a company with a market cap of under £20bn. This does not include the initial contract on the SEA 5000 programme, or the contract for the supply of Typhoon and Hawk aircraft to Qatar, both expected in the second half.

Most Systems go

However, the company is not quite firing on all cylinders. Sales and underlying earnings both dipped slightly in the first half, and although there were reasons, such as reduced Typhoon production activity, it hardly excites. Basic earnings per share were down 17% to 14.8p.

We may see more signs of a recovery next year, when EPS are forecast to rise 9%, which would trim the valuation to 13.4 times earnings, so you may want to dig in now and wait. Operating margins are forecast to rise from 7.4% to 8.9%. This engineering stalwart deserves a place in your portfolio alongside HSBC, but if I had to choose one, it would be the bank.

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harveyj 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.

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