The Aspects of Financial Life in the UK - Essay Example

1.0 INTRODUCTION: This paper envisages providing an analytical insight into the investment decision on the stocks of two major multinational banking Institutions, both of them rated high in their own merits. By adopting certain basic parameters of analising the key financial indicators, we can arrive at a logical decision as to which of the stocks fares better and qualify itself for an investment with a long term perspective. 2.0 BRIEF DESCRIPTION OF BARCLAYS BANK (QUOTE BARC) To briefly describe: Barclays is an old bank dating its origin to 17th century based in London, engaged in a multiple range of banking business activities like investment banking, retail banking, credit card, mortgage lending, and wealth management. Barclays has over $244 billions in assets under management and ‘Barclays Global investors’ manage 65 of the world’s top 100 largest pension plans. Barclays has spread its wings in 37 countries outside the United Kingdom and a strong presence in Africa through acquisitions. Barclays also provides a hedge against falling US dollar which is now at a 14 year low against pound sterling. ‘Barclays capital’ handles foreign exchange, derivatives, and fixed income business. 3.0 BRIEF DESCRIPTION OF HSBC BANK (QUOTE HSBA) HSBC holdings have emerged as a single largest bank in the world operating with 9800 branches in nearly 80 countries. The group has identified itself as a giant in providing consumer and commercial banking services, credit cards, asset management, private banking, securities trading, insurance and leasing. The operations of the bank in the United States include HSBC USA with the purchase in the year 2003 of the consumer lender ‘Household International’ now known as ‘HSBC Finance’. 4.0 ANALYSIS OF THE INVESTMENT DECISION The analysis of the investment decision is to be based on the key indices as mentioned below and each of these data would offer the necessary inputs for deciding on the investment idea. 4.1 KEY INDICES HSBC BARCLAYS Market Cap US $ Millions 203,175.4 92,928.5 Current Dividend 4.55 2.04 Dividend Yield 5.00% 3.58% Historic Dividend Growth 8.19% 21.55% % Return from Dividends 37.22% 22.96% Share Price Change Year to date 13.00% 35.72% PE Ratio 11.84 11.37 Earnings per share EPS (current year estimate) 7.68 5.02 Earnings per share EPS (next year’s estimate) 8.18 5.52 Projected EPS growth 8.44% 12.00% Expected return 13.44% 15.58% Price/Sales Ratio 2.25 1.92 60 month Beta 0.80 1.20 5 year Growth rate 15.32 9.99 From the above data, consideration of earnings per share, Price/Earnings ratio, dividend yield, Beta risk and movement of individual share prices, which are the major criteria apart from the others, would provide a clear indication about the stocks in which the investment should be made. 4.2 EARNINGS PER SHARE By ‘earnings per share’ (EPS) we mean the consensus analysts’ current fiscal year as well as the next fiscal years earnings per share. In the present analysis, the EPS of HSBC is far in excess than that of Barclays both for the current fiscal and the next fiscal. It is 7.68 and 8.18 respectively in the case of HSBC as against 5.02 and 5.52 for Barclays. The stocks of HSBC qualify for investment on this score than that of Barclays. 4.3 PRICE TO EARNINGS RATIO (P/E RATIO) The Price to Earnings (P/E) Ratio is a companys Last Closing Price divided by the current year estimate of earnings per share (EPS). To consider an investment worthy, the price to earnings should be at a lower rate. In numerical terms the P/E ratio for Barclays is 11.37 as compared to 11.84 of HSBC. Considering this aspect, the shares of Barclays offer a better choice as compared to that of HSBC. 4.4 DIVIDEND YIELD Dividend Yield is calculated by dividing a companys Current Dividend by its Last Closing Price. The dividend yield is 5% in the case of HSBC and 3.58% for Barclays. In order to decide in favour of investing in the stocks of a company with a short term perspective in view, the dividend yield should be more. In the present analysis, if the investor is having the idea of quick and enhanced returns, it would be advisable to invest in the shares of HSBC as the dividend yield is higher compared to that of Barclays. 4.5 DIVIDEND DISCOUNT MODEL (DDM) The dividend discount model is a widely accepted stock valuation tool which calculates the present value of the future dividends that a company is expected to pay to its shareholders. By using this model it becomes possible to find out the intrinsic value of a particular company without the influence of the current stock market conditions. However this model has a drawback that it cannot be applied without the necessary data and analytical tools. For the limited purpose of analyzing and advising on the investment in the stocks of HSBC and Barclays we would take the ‘Projected EPS Growth’ and the “Expected Returns’ values as indicated above in 4.1. By a comparison of the real values as depicted in clause 4.1 under the projected EPS growth and expected returns, the shares of Barclays rank higher than that of HSBC and with a long term perspective in view the shares of Barclays have more intrinsic value than HSBCs’ stock, as both the values are higher at 12% and 15.58% as compared to 8.44% and 13.44% respectively. 4.6 ALPHA AND BETA RISK FACTORS Alpha risk relates to factors affecting the performance of an individual stock or the manager’s skill in selecting the particular stock, whereas, the beta risk refers to the market risks or more specifically the relative behaviour of different shares. Beta risk is therefore the measure of how sensitive the price of a specific stock is to changes in the prices of different stocks in the stock market. Thus Beta neutral portfolio should be insensitive to swings in the stock market. In other words, the beta factor is regarded as volatility and is often reckoned as a negative force in a portfolio, because it affects the stability of returns and results sometimes in the risk of loss of the principal. To arrive at a proper investment decision, the managers perform statistical analysis to rank the securities according to their expected returns and risk factors and this process is called quantitative risk analysis. From this they make their own judgments on stock selection to enhance the alpha risk and minimise the beta risks. Beta coefficient is a measure of a stocks volatility and a company with a beta of less than 1.0 has below average volatility, and vice versa. By using this analogy, the shares of Barclays has above average volatility with a 60 month beta coefficient of 1.2 and the shares of HSBC have a below average beta coefficient of 0.8. This means that the HSBC shares are less volatile and hence preferable for investment than the shares of Barclays. However the beta coefficient of 1.2 in the case of Barclays, which is just above 1.0, is not that alarming to make the shares of the company to be rejected outright for investment considerations. 4.7 DIVIDEND GROWTH RATE Another important factor from the point of view of investment in the stocks of a company is the consistency in paying dividends by the company over the past few years, which is evidenced by the dividend growth rates of the company over the specified periods. The following are the dividend growth rates of Barclays and HSBC over the last 5 year period: 12 months 36 months 60 months Barclays Bank 10% 66.3% 130.2% HSBC Bank 31.9% 32.9% 72.4% From the above it may be observed that the dividend growth in the case of Barclays is showing a considerable improvement over that of the HSBC. In the case of Barclays, the lower dividend growth rate of 10% in the last twelve months (the lower growth rate may be due to many other considerations by the Bank extraneous to the share values but beneficial for the Bank in the long term) has affected the 5 year growth rate drastically resulting in 9.99 for Barclays as compared to 15.32 of HSBC. However the significant ratios are the ‘expected Returns’ and the ‘Projected EPS growth’ which determines the stability of the company’s stock holdings. 5.0 OTHER CONSIDERATIONS Apart from the major consideration enumerated above there are other considerations which also plays a role in deciding on the investment in the shares of a company. They are Price to sales ratio, Price to book ratio, price to cash flow ratio, return on equity, return on assets etc. These are the normal tools an analyst uses in his judgment about the investment decision. Although these ratios are indicators of the financial strength and the stability of the company, the relative importance attached to these ratios is less. To illustrate the price/sales ratio for HSBC is 2.25 as against 1.92 in the case of Barclays. This means that Barclays stand a better chance to qualify for investment than HSBC. Apart from the financial indicators, market considerations also play a very prominent role in arriving at the best investment decisions. For instance Barclays does not face the mortgage default and weak housing risks as the British housing and mortgage industries are very strong right now. However the profit margins of Barclays are well below at 18.34% and there is also the risk of the rebounding of dollar leading to a drop in the price of Barclays ADR shares. Similarly for HSBC also there are factors like the size of the organization with its largest market cap, largest number of employees, huge asset holding as compared to Barclays, higher income growth which go in favour of deciding for investment in the shares of HSBC. 6.0 CONCLUSION From the foregoing discussion on the various financial and non-financial indicators of both HSBC and Barclays Bank a careful evaluation of all the factors affecting the investment decision can be made. For a serious investor at the first instance it may be really difficult to make up his mind as stocks of both organizations weigh equally. However one has to decide about the period for which the investment is to be held. Decision may change depending upon whether the investment is to be held for a shorter duration or for a long term. Considering the various ratios and other arguments in favour of and against both the stocks the following conclusion may be drawn: a. when the investor is interested in getting quicker returns and wants to change the portfolio after making some decent returns by way of dividends, without really looking for consolidation of asset backing for the investments, then investment in the shares of HSBC would prove profitable and it can be strongly recommended that the shares of HSBC can be bought for a short or medium term of investment to earn reasonable dividend income. Presently the growth potential of the company is very high and the share prices are also at a comparatively low level. Now the consensus recommendation for the shares of HSBC is to ‘buy’, which will definitely prove worthwhile in the short/medium term investments as the returns are posing a really attractive avenue for investment. b. On the other hand, if short term profitability is not in the scope for investment and the investor is really interested in the intrinsic value of the shares vis-à-vis the asset backing for the equity investments, buying the stocks of Barclays would be strongly recommended. Though not fabulous, the investor would be getting a reasonable return on his investment s and the growth potential for the earning per share is tremendous in the long run. Thus when the investment is considered for a longer time period the advice would be to invest in the shares of Barclays, where the projected EPS growth as well as expected returns is high. Although the current dividend and dividend yield indices are lower due to the fact that the company has paid a lower dividend due to extraneous considerations, the historic dividend growth rate is high as compared to that of HSBC (21.55% against 8.19%) which is surely a positive indicator that the company will do enough justification for investing in its shares during the long term. However it may not be proper to provide an advice of two alternatives for any investment decisions – one for short and medium term and the other for long term investments. To arrive at a proper investment decision in the present analysis, considering the various factors discussed in detail, although the volatility of the shares of Barclays Bank is slightly higher than that of HSBC and the current dividend level is lower, it is strongly recommended that the investor can buy the shares of BARCLAYS having higher expected returns and projected earnings growth rate coupled with the long term dividend growth rate and a strong intrinsic value of the assets. REFERENCES 1. Alternative Investments: Risk and Return viewed 14 December 2006 < http://www.financial-guide.ch/ca/investing/alternative_investments/risk_and_return/index.html> 2. BARCLAYS share price & Tools viewed 14 December 2006 < http://www.investorrelations.barclays.co.uk/BRC1/jsp/brccontrol?task=articleforgroup&site > 3. Dividend Discount Model viewed 14 December 2006 < http://dividenddiscountmodel.com > 4. Suriya Investment News Letter viewed 14 December 2006 < http://www.sinletter.com/archives/SINLetter December 2006. html > Read More