To invest in the banking sector, you need to know and understand the key items that will have an impact on share prices.
Banks remain popular with institutional investors despite the calamitous events of the past decade. While catastrophic losses have battered the sector - and continue to do so - investors are attracted by the traditional status of banks as good dividend payers.
What should investors look for in order to make an informed judgment on dividend potential? Investors need to look at a relatively small number of metrics in order to make that decision: dividend yield, dividend cover and expected dividend growth.
Which bank to invest in? Essential metrics
- Income: how much is the bank earning?
- Where is it coming from both in terms of products, geography and sectors?
- Interest income on personal loans, mortgages and credit cards?
- If so, are the margins appropriate to the risk involved?
- Is it fee income?
- If fee income, are the fees a one-off or recurring? Penalty charges? Commission?
- What is the trend in income? Up? Down? Steady? Rapidly growing? Rapidly falling?
- A bank will ask for at least three years of figures when considering a loan application. Investors would be well advised to do the same before parting with their cash.
- And they should bear in mind that banks are more adept than most at window dressing to flatter their figures on any given date.
Yield, cover and growth
Dividend yield is the most recent dividend payment expressed as a percentage of the current share price.
At the time of writing (12 May 2017) the Financial Times lists The Royal Bank of Scotland yield as zero (it is still making losses and can't pay dividends). Lloyds Bank is listed at 3.37%. HSBC is 6.13%. Barclays, struggling with management and reputational issues, is 1.45%.
Dividend cover is the amount of times that earnings cover the dividend payment; twice is regarded as a market norm but this is not set in stone. Expected dividend growth is self-explanatory: the forecast for future growth in the dividend payment.
In a perfect world the yield and cover would remain constant in arithmetical terms as growth takes place. But as the world's banks have been reminded in recent years, the world is far from perfect.
Costs and provisions
- Are costs rising? Falling? Steady?
- What is the cost to income ratio? What is its direction of movement?
- What is the bank's provisioning policy?
- How much does it routinely set aside against bad debts?
- Is that cash or percentage figure rising or falling?
Bear in mind that provisions for bad debt do not mean that the debt in question will be bad. Provisions against debt that turn out to be unnecessary will either be written back and flow straight into the bottom line, or reduce the need for future provisions.
Beyond the dividend
Moving beyond the dividend, investors need to take into account a broader range of numbers to assess the underlying quality of the institution concerned. Yield, cover and growth all depend upon levels of capital and the strength of the underlying business.
Banks are arguably more exposed than other forms of business to the economic and political fundamentals of the economies in which they operate. This is probably because there are so many elements over which they have no control.
These include the level of interest rates, the expected direction of travel of interest rates, economic growth, economic forecasts and general levels of confidence.