In August’s half-year results report, chief executive of Lloyds Banking Group (LSE: LLOY), António Horta-Osório, told us that the firm achieved “another strong financial performance with increased statutory profits, higher returns, and a strong capital build.” However, the shares have been sinking all year and there’s no sign that the downward trend has ended, so what’s going on?
Bye-bye buybacks
Recent news that the firm has completed its share buyback programme won’t be helping the share price. Between March and August, Lloyds spent £1bn buying back more than 1.5bn of its own shares, which will have propped up the stock for a while, but now that pillar of support has fallen away. I’ve been bearish on Lloyds since the beginning of 2013 arguing that the firm’s cyclicality would likely cause the stock market to compress the firm’s valuation. Profits have been high for a while and will likely fall on the next cyclical down-leg at some point. I reckon that’s why Lloyds’ valuation keeps getting lower. The market is trying to anticipate the next plunge.
Yet it announced an “ambitious” strategy in February to “transform the Group for continued success in a digital world.” Mr Horta-Osório said in the interim report that “significant” business progress includes the successful delivery of Open Banking, the launch of Lloyds Bank Corporate Markets and the planned integration of MBNA and Zurich’s UK workplace pensions and savings business. He said a “strong start” had been made implementing the strategic initiatives designed to “further digitise” the company.
None of that will necessarily send the share price higher though. The market is in charge of where the share price goes and the market ‘knows’ that Lloyds is an out-and-out cyclical proposition. Because of that, my opinion is that the upside for investors from here is severely capped with Lloyds. So, I’d shun Lloyds’ shares and pile into a dynamic company such as the FTSE 100’s Diageo (LSE: DGE) instead.
Strong, consistent performance
In July’s full-year report, chief executive Ivan Menezes told us that the premium alcoholic drinks supplier had achieved another year of “strong, consistent performance.” Reassuringly, he said that organic volume and sales growth was “broad-based” across regions and categories.
Diageo’s record of cash generation is impressive and the cash flowing into the business provides robust support for earnings. The defensive and steady nature of the firm’s trading is a world away from the cyclical operations over at Lloyds Banking Group. I think that Diageo is by far the better company of the two for a long-term investment. The outlook for earnings growth is positive and the company has been helping the share price with its own share repurchase programme too. During the trading year to June 2018, it spent around £1.5bn buying back its own shares and plans to spend a further £2m or so on buybacks during the current trading year.
I think Diageo is well worth your further research time especially if you plan to buy and hold the stock for the long term.
