If you're building a portfolio of FTSE 100 stocks to boost your retirement income, then it's hard to ignore the banking sector.
Big banks such as HSBC Holdings (LSE: HSBA) and Barclays (LSE: BARC) have provided reliable dividends for their shareholders for hundreds of years. But nearly 10 years after the last banking crisis, these financial heavyweights are still struggling to win back the confidence of their investors.
Today I'm going to take a look at the current performance of both banks. For investors seeking a long-term income, which is the better buy -- and why?
Value versus yield
HSBC and Barclays are very different businesses. Barclays' focus is mainly on UK retail banking and on US-UK investment banking. In contrast, HSBC has always been focused on serving the needs of individuals and businesses in Asia and the UK.
HSBC was the only one of the five big FTSE 100 banks that didn't receive a bailout or raise cash by selling new shares after the financial crisis. And its profits have recovered much more quickly, helped by its strong exposure to the Chinese economy.
Today, the Asia-focused bank trades at a notably higher valuation than Barclays. Despite this, it also offers a much higher dividend yield:
Price/Tangible Book value
2018 forecast P/E
2018 forecast dividend yield
HSBC is able to make more generous returns to shareholders for two reasons. First of all, its balance sheet already carries more surplus capital than that of the smaller bank. At the end of June its Common Equity Tier 1 ratio (a regulatory measure) was 14.2%, compared to 13% for Barclays.
The other difference is that the Asia-focused bank is also more profitable, having already resolved most of its legacy issues from the financial crisis.
This process is still ongoing at Barclays, where litigation and conduct costs totalled more than £2bn during the first half. This reduced the group's pre-tax profit from £3,701m to £1,658m.
Barclays may be on the cusp of delivering much higher levels of profitability. Excluding these misconduct costs, Barclays' would have reported a return on tangible equity of 11.6% for the first half of the year.
That's well ahead of the equivalent figure of 8.7% reported by HSBC. Barclays' returns are lagging at the moment, but the upside potential is clear. In contrast, HSBC's profits are already fairly clean. Growth will depend on expansion and on improving the profitability of its operations.
HSBC's forecast yield of 5.8% looks safe to me and is well above the market average. However, the potential for growth may be limited. Earnings are expected to rise by just 4% in 2019 and dividend cover is already relatively low, at 1.4 times. So I don't expect the dividend to rise very quickly.
Meanwhile, Barclays offers investors the chance to profit from a re-rating if chief executive Jes Staley can fix the bank's remaining problems and improve its profitability.
Dividend growth may also be much stronger at the UK-focused bank. This year's yield of 3.6% is expected to be covered 3.2 times by earnings, leaving plenty of room for growth when demands on the group's cash ease.
If I wanted a reliable high-yield income today, I'd buy HSBC. But if planning for years ahead, I'd consider choosing Barclays for its turnaround potential.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays and HSBC Holdings. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.