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The Stock Picker’s Guide To Lloyds Banking Group PLC

Successful investors use a disciplined approach to picking stocks, and checklists can be a great way to make sure you’ve covered all the bases.

In this series I’m subjecting companies to scrutiny under five headings: prospects, performance, management, safety and valuation. How does Lloyds Banking (LSE: LLOY) (NYSE: LYG.US) measure up?

1. Prospects

Predominantly a UK retail and commercial bank, Lloyds has a 50% share of the UK savings market and 30% share of mortgages, though those shares will diminish with the EU-enforced sale of former TBS branches.

The bank’s fortunes are tied to:

  • Success in resolving the legacy issues mostly arising from its disastrous acquisition of HBOS in 2008. It is reducing non-core assets, shedding costs and strengthening capital;
  • The UK economy.  Lloyds will benefit from the Chancellor’s initiatives to boost the housing market, though ultimately suffer if it leads to another house price bubble.

With the shares hovering around the Government’s (somewhat arbitrary) break-even price, disposal of at least some of its 39% shareholding is likely before the general election in 2015, possibly with an early sale to institutional investors.

2. Performance

Lloyds was a conservative, low-risk bank earning a high return on capital for many years before its purchase of HBOS.

The turnaround is approaching successful completion: costs down £2bn from 2010’s £11bn, assets down, impairments reduced, deposits funding 100% of ‘core’ assets (and over 80% of total assets) and capital strengthened.

Furthermore, last quarter’s results suggest growth may be returning to volumes and margins.

3.  Management

Chairman Sir Win Bischoff, who has been a steadying hand since 2009, is to retire by next May. After initially stumbling with micro-management, work-related stress and internecine warfare, CEO Antonio Horta-Osorio is pulling off a successful turnaround.

4. Safety

Lloyds remains exposed to legacy issues including PPI mis-selling, a large Irish loan book and sub-standard real-estate loans.  Though its southern European exposure has been brought under control, the potential for contagion in the banking sector means that tail risks such as a eurozone blow-up would still affect Lloyds badly.

Rebuilding of its capital has been running ahead of plan. Though the Prudential Regulatory Authority declared Lloyds had a £9bn shortfall at the end of last year, the bank maintains that around half has already been raised and the balance can be met without new equity.

5. Valuation

Lloyds’ shares are trading at about book value (and 1.1 times tangible net assets). Its projected price-to-earning ratio of 12.8 is toppy compared to the rest of the sector. Expectations of a modest resumption in dividend payments give it a prospective yield of 1.3%

Conclusion

The shares look fully priced given the risks and exposure to the UK economy. However, further progress on shedding non-core assets, sale of some government shares and resumption of dividends could all spark improvement.

There are safer bets on the market, such as the five companies in this report. They each have dominant market positions, healthy balance sheets and robust cash flows that underpin their reliability and future dividends.

You can download the report by clicking here — it’s free.

> Tony does not owns any shares mentioned in this article.