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The bull and the bear – breaking down our clients’ top share holdings

We take a look at both sides of the coin for some of our top client holdings.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

Beauty is in the eye of the beholder, and as it turns out, so is value.

A 1980s study asked three groups of people to give a price to identical mugs. The first group would have to buy the mug themselves. They believed the mugs cost $2.87. The second could choose a mug or cash. They valued the mugs at $3.12. The final group were given the mugs. When asked how much they were worth, this group said $7.12 – more than double the others.

The study showed that perceived value changes drastically depending on whether or not you own something, and it can manifest in investing as well. It’s often more difficult to sell shares than it is to buy them. While we encourage investors to take a long-term view, periodic reviews and rebalancing are an important part of any investing strategy.

To lend a hand, we’ve taken a look at some of HL clients’ most popular shares to outline both sides of the investment case.

Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

This article isn’t personal advice. If you’re not sure whether an investment is right for you, seek advice. Investments will rise and fall in value, so you could get back less than you invest.

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Lloyds – banking on an economic recovery

Past performance isn’t a guide to future returns. Source: Refinitiv, 20/09/21.

The UK’s banks found themselves under a great deal of pressure in 2020 after years of ultra-low interest rates. Interest rates determine how profitable their loans are. Bank stocks are cyclical, meaning their fortunes wax and wane with the health of the economy. So, the economic shocks from the pandemic hit financial institutions hard.

Lloyds is no exception – in fact, the group lacks an investment banking arm and relies heavily on lending. Low interest rates mean the group’s loans haven’t been very profitable of late. Net interest margins, a measure of loan profitability, are expected to hover around 2.5% this year, which isn’t particularly impressive.

The bears would point to the fact that interest rates have been on the floor for years and are unlikely to rise anytime soon. That will take a bite out of Lloyd’s profitability no matter how you slice it. Plus, the pandemic-related uncertainty still hasn’t cleared from the economic outlook, so cyclical stocks like banks aren’t necessarily on for smooth sailing just yet.

On the other hand, the past year was probably just about as bad as it can get for banks. All things considered, Lloyds handled it pretty well. The bank was forced to set aside masses of reserve capital when the pandemic struck. But much of that is being released, leaving plenty of cash (nearly £6bn ) to return to shareholders, or build out new income streams.

Lloyds is looking to grow beyond high street lending into industries less dependent on interest rates. Long term, this is a strong move. The bank recently bought Embark, an investment and retirement platform, as part of this strategy.

With a prospective dividend yield of 5.6% on offer, shareholders are likely to be rewarded for waiting out this transition. Though as we saw last year, dividends are never guaranteed. Yields are also variable.

The bottom line:

The long-term case for keeping Lloyds rests on two factors: whether you think interest rates will rise, and whether you believe the bank can successfully diversify away from its high street lending business.

The latter is something Lloyds is certainly capable of – the bank’s got the firepower and position to make good on this shift, though getting it right is still a risk. The former is harder to forecast. But as things stand, it looks likely that rates will remain unchanged until mid-to-late 2022.

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BP – drilling down on clean energy

Past performance isn’t a guide to future returns. Source: Refinitiv, 20/09/21.

The astronomic rebound in oil prices over the past year has given BP a bit of breathing room after a few difficult years. Oil and gas stocks found themselves in a sticky situation last year as both uncertainty in the economy and an unprecedented drop in oil prices weighed on sentiment. Add to that the fact that the world is looking to shift away from fossil fuels in favour of cleaner energy solutions, and you have an uncertain environment.

For its part, BP’s done well to weather the storm. The group’s used the past year’s spoils to shore up the balance sheet and kick start a massive buyback programme that will make its dividend payments more affordable. Having fewer shares in circulation will scale back dividend obligations. In theory, this should make the group much more capable of covering, and eventually raising, dividend payments.

To fund this plan over the next few years, the group plans to continue selling off parts of its business to keep debt affordable and buy back shares.

This isn’t exactly a long-term solution, though. Eventually BP will need to organically generate enough cash to support dividend payments and service its debt. However, the changing landscape of the energy space has made this a tall order.

BP’s also using some of its spare cash to fund a pivot toward gas and low carbon projects. While we can’t knock management for trying to position the energy giant for the future, this shift will be expensive and time consuming with a lot of room for error.

The group expects to be spending $5bn per year on low carbon energy projects in less than a decade. We’re concerned BP might be moving too fast and disposing of oil assets that have the potential to generate returns well into the future. Ultimately BP is swapping its high-return oil and gas fields for unproven, lower return renewables that are expensive to build out. It’s a risky strategy.

Still, the existing business is in good enough health to underpin an expected dividend yield of 5.3%. As ever, remember yields are variable and not guaranteed.

The bottom line:

BP’s long-term future depends on execution. If the group can rise to the top of the clean energy space as it did among oil and gas competitors, it could be worth the wait. The group’s size and scale make it a formidable player, and while clean energy might be the future, there’s still a lot of money to be made in the black stuff.

There’s no immediate concern about BP’s financial status, but we’re mindful that a lot can change with a strategy shift as large as this one on the table.

View the latest BP share price and how to deal

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GlaxoSmithKline – leaning on pipeline promises

Past performance isn’t a guide to future returns. Source: Refinitiv, 20/09/21.

If there’s one thing we’ve all learned over the past 18 months, it’s that drug development is complex and often unsuccessful. All drug makers struggle with this truth – it’s part of the reason drugs are so expensive. Developing new drugs is an expensive endeavour, and only a handful of potential treatments make it through to the trial phase. Even fewer are ultimately approved.

That’s why GlaxoSmithKline is so hard to value. The group’s offered ambitious growth targets, all backed by new treatments in various stages of development. But as none of these products have been approved yet, we can only go on what exists at Glaxo today – and that picture isn’t quite as rosy.

The group’s planning to spin off its Consumer company in a demerger. That means GSK shareholders will wind up with shares of New GSK in addition to their current holding. This separation is still nearly a year away, but will divide the business in such a way that the group can more readily service its not insubstantial debt obligations.

The consumer business will be lumbered with most of the company’s debt, with net debt equal to roughly 4 times cash profits (EBITDA). That’s because this business has fewer capital requirements and a more predictable revenue stream. The pharmaceutical business will take on a much smaller proportion, though at around 2 times cash profits, it’ll be worth keeping an eye on.

The leaner pharmaceutical business is expected to post double-digit operating profit growth over the next five years, helped by recently approved HIV treatments and growth in Vaccines and Specialty Medicines.

But if the pipeline drugs don’t progress as management’s hoping, we could see the prospective dividend yield of 4.6% deteriorate. Free cash is far from covering dividend payments, which has sent debt levels higher. Unless the group can get this under control with profitable new treatments, things could get worse.

The bottom line:

Glaxo’s toeing a fine line between rewarding shareholders for waiting out the storm and overextending itself. If the group’s pipeline can deliver, the stock could be in for a strong recovery. But the ‘if’ is doing a lot of work here. We’ve all seen how volatile the drug approval process can be and Glaxo’s tougher financial position increases the risks of ups and downs.

View the latest GlaxoSmithKline share price and how to deal

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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