Banks are market leaders in valuation terms – Fidelity

The banking sector is the market leader in valuation terms, says Fidelity’s Alex Wright, and investors can once again feel comfortable with it.

Banks are market leaders in valuation terms - Fidelity

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With the post-financial crisis fog dissipated and the threat of an increased UK bank levy being removed, after six long years the banks are finally seeing the light at the end of the tunnel.

Of course, there is still some work to be done – as evidenced by Barclays’ ousting of CEO Antony Jenkins last week – but overall the picture seems to be improving, and is presenting some attractive dividend opportunities.

“Banks are the strongest sector in the market on a valuation point-of-view,” said Wright, manager of Fidelity’s UK Equity Contrarian Fund range.

“There are some much-improved companies that are still at very low valuations, such as Lloyds and Bank of Ireland, which have 25-40% market share in their domestic markets. They are increasingly simple and well-capitalised banks that should be able to pay out high dividends over time.”

Wright says that, with one or two exceptions, an industry-wide upturn in dividends should see both equity and equity income investors – whom he believes have been reluctant to enter the space since the financial crisis – regaining confidence in the banking sector.

“Pre-crisis price-to-book valuations were at 1x or a bit higher, while post-crisis they are significantly lower,” he explained. “We have not actually seen any re-rating of banks in the past six years, whereas capital ratios have been dramatically increasing and therefore safety in the strength of the balance sheets. We are expecting pay-out ratios of more than 60% of earnings by 2016, which will give the 6% dividend yield that we are likely to see.

“Income investors have not been in this space because they are worried about regulatory changes and weak balance sheets. However, these are yesterday’s problems – the banks have worked through a lot of the challenges, and going forward the sector is going to pay out steady high income, which will eventually lead to a re-rating.”

Seizing the day

Banks represent the largest overweight in Wright’s Special Situations Fund at just under 8%, with HSBC, Lloyds and Citigroup occupying the top-three stock holdings at 6.1%, 4.6% and 4.2% of the portfolio respectively, while Barclays carries a 2% weighting.

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