I do believe that Lloyds (LSE: LLOY) shares offer the opportunity to build wealth through dividends and future growth.
However, there are several challenges the firm faces that could hurt earnings and returns. For that reason, I’d prefer to buy British American Tobacco (LSE: BATS) shares to capitalise on juicy returns.
Challenges for Lloyds shares
From a bullish view, Lloyds is a pivotal cog in the UK’s banking ecosystem. It possesses a dominant market share from a mortgage perspective, with around a fifth of the whole UK market. The housing imbalance in the UK could present growth opportunities to boost earnings and returns here.
The shares offer a dividend yield of just over 5%. However, it’s worth remembering that dividends are never guaranteed. Plus, the shares trade at bargain levels, on a price-to-earnings ratio of just nine.
Moving to the other side of the coin, I have real concerns over the shareholder value Lloyds could offer me.
Firstly, if interest rates come down, net interest margins will come down too. Although rate cuts could be beneficial for new business, this dent in earnings could hurt the firm.
In terms of new business, competition is hotting up in the banking sector, especially from the likes of challenger banks like Monzo and Starling. These up-and-comers seem to be resonating well with customers, as demonstrated through high customer satisfaction scores.
Finally, the recent issues with higher interest rates leaves Lloyds at the mercy of bad loans and mortgage arrears, which is something that doesn’t sit well with me as a potential investor.
Dividend giant
Many investors have begun turning away from smoking giants like British American Tobacco. This is due to the rise in ESG investing, given the harmful effects of smoking. Decreasing smoking numbers could have a detrimental impact on the business, and its shareholders’ returns. This is a risk I’ll keep an eye on.
However, I’m of the belief that there are lots of dividends to be gained from a stock that earns cash hand over fist and rewards its investors, and has done so for many years. However, I do understand that past performance is never a guarantee of the future.
Speaking of the future, British American Tobacco is navigating the changing face of smoking and is developing non-tobacco alternatives. Based on recent updates, these seem to be popular and helping the business perform well.
In addition to this, despite the threat of changing laws, it’s 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 returns in the meantime.
A dividend yield of over 8% is hugely attractive to me. Furthermore, the business continues to initiate share buybacks, which is another feather in its cap. Plus, the shares aren’t expensive in my view. They trade on a price-to-earnings ratio of just over 12.
Overall, British American Tobacco, as a nimble, cash-generating, investor-rewarding stock, looks like a great option to me. This is compared to Lloyds, as a financial services business under attack from disruptors, as well as prone to economic volatility.
