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I think that Lloyds (LSE:LLOY) shares offer the opportunity to build wealth through dividends and future growth.
However, the company is facing several challenges that could affect its earnings and profitability. For that reason, I would prefer to buy British American Tobacco (LSE:BATS) shares to capitalize on juicy returns.
Challenges for Lloyds shares
From a bullish perspective, Lloyds is a key element of the UK banking ecosystem. It has a dominant market share from a mortgage perspective, with around a fifth of the total UK market. The UK housing imbalance could present growth opportunities to boost earnings and returns in the country.
The stock offers a dividend yield of just over 5%. However, it is worth remembering that dividends are never guaranteed. What's more, the stock is trading at bargain prices, with a price-to-earnings ratio of just nine.
Turning to the other side of the coin, I have real concerns about the shareholder value that Lloyds could offer me.
First, if interest rates fall, net interest margins will fall as well. While rate cuts might be beneficial for new businesses, this dent in earnings could hurt the company.
In terms of new businesses, competition is increasing in the banking sector, especially from emerging banks such as Monzo and Starling. These new banks seem to be getting a good reception from customers, as evidenced by their high customer satisfaction ratings.
Finally, the recent problems with higher interest rates leave Lloyds at the mercy of bad loans and mortgage arrears, something that doesn't sit well with me as a potential investor.
Dividend Giant
Many investors have started to move away from tobacco giants such as British American Tobacco. This is due to the rise of ESG investing, given the harmful effects of smoking. The decrease in the number of smokers could have a negative impact on the business and its shareholders’ returns. This is a risk I will be monitoring closely.
However, I do believe that there are many dividends to be gained from a stock that makes money hand over fist and rewards its investors, and has done so for many years. However, I understand that past performance is never a guarantee of future performance.
Talking about the future, British American Tobacco is addressing the changing paradigm of smoking and is developing non-tobacco alternatives. According to the latest updates, these seem to be popular and are helping the business perform well.
On top of this, despite the threat of changing laws, it is not something that will happen overnight. These types of initiatives can take years, if not decades. British American Tobacco has the presence, brand power and know-how to continue to deliver excellent results and profitability in the meantime.
A dividend yield of over 8% is hugely attractive to me. Plus, the company keeps buying back shares, which is another point in its favor. Also, the stock is not expensive in my opinion. It trades at a price-earnings ratio of just over 12.
Overall, I think British American Tobacco, as a nimble, cash-generative, investor-rewarding stock, is a great buy compared to Lloyds, as a financial services company that is under attack from disruptors and prone to economic volatility.
