Specialist lender and banking group Paragon(LSE: PAG) has released upbeat results today. They show that it has recorded a rise in underlying profit of 9.1% as a result of organic growth, diversification, M&A activity and effective capital management. So far in 2016, Paragon's capital gains have beaten those of Barclays(LSE: BARC) by 9%. Will this trend continue?
Paragon's revenue rise was accompanied by greater diversification. Non buy-to-let lending made up 29.5% of group lending versus just 11% in 2015. This shows that Paragon now offers a more stable income stream ahead of what could prove to be a challenging period for the buy-to-let industry. Tax rises and uncertainty surrounding Brexit could negatively impact on the sector, which makes Paragon's earnings profile more appealing now that it is less reliant on buy-to-let.
Against a challenging backdrop, Paragon's results are strong. Total completions and asset purchases increased to £1.65bn versus just under £1.5bn last year. Its earnings rose by 14.1% and underlying return on tangible equity improved to 13.2% versus 11.4% in 2015. This was as a result of profit growth and the company's share buyback programme. On this topic, a further £50m share buyback programme will be undertaken.
Paragon's core equity tier 1 (CET1) ratio of 15.9% and leverage ratio of 6.2% indicate that the lender is financially sound. Alongside its rising profitability, this provides it with the scope to raise dividends by 22.7% to 13.5p per share. This puts Paragon on a yield of 3.9% and with its dividend being covered 2.8 times by profit, there is potential for it to rise rapidly.
Certainly, Paragon has greater income appeal at the present time than Barclays. The latter yields just 1.4% following its decision to cut dividends in favour of strengthening its financial position. This makes sense for the long term and should create a more stable bank which has a lower risk profile.
In this respect, at least, Barclays has more appeal than Paragon, since Paragon is in the midst of a transitional period, one that will see it move from being a non-bank that focuses on mortgages, to a retail-funded banking group. While this change brings with it great opportunity to win new customers and grow its bottom line, it also means that there are potential challenges and delays ahead.
Looking ahead, Paragon's earnings are forecast to flat line in the current financial year. However, with a price-to-earnings (P/E) ratio of just 9.1, it has significant upward re-rating potential. This compares with Barclays's expected growth rate of 58% next year. This puts Barclays on a forward P/E ratio of 10.9, which, while higher than Paragon's P/E ratio, indicates that there is still a wide margin of safety on offer.
With Barclays having a lower risk profile, given Paragon's transition towards being a bank during a highly uncertain period for the UK economy, Barclays appears to have the superior risk/reward ratio. Therefore, while Paragon could deliver significant capital gains in future, Barclays offers the greater investment appeal right now.
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Peter Stephens owns shares of Barclays. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.