Shares of Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) started this year at 79p and look like ending the year little changed.
This is despite the analyst consensus on earnings having edged up over the period, such that Lloyds now trades on a seemingly “bargain” rating of around 10 times current-year forecast earnings.
What’s going on? Why aren’t investors snapping up this bargain? Will things change in 2015, and will the shares rocket higher?
Sentiment
A General Election next year, uncertainty about how long it will take the government to fully dispose of the 25% of Lloyds’ shares it still owns, and uncertainty about when the bank will resume paying dividends may all be weighing on sentiment. But I think even when we’ve moved on past these things, the reality of hard valuation numbers will be a sticking point with the market.
I think valuation will keep a lid on Lloyds’ shares in 2015. Or, at any rate, that the Black Horse’s shares will be outpaced by some of the UK’s other banks.
Valuation
Let’s begin with that bargain price-to-earnings (P/E) ratio of 10. This is based on analyst forecasts for “adjusted” or “underlying” earnings per share (EPS) of 7.8p — that’s to say, earnings without all the bad stuff, a.k.a. fantasy earnings.
To give some idea of how far real earnings lag behind adjusted earnings, statutory EPS for the year to date stands at just 1.7p. EPS of, say, 2.6p for the full year, gives a real P/E of 30.
It will be a good few years before real EPS catches up with the fantasy figure — even if the broad economic backdrop remains reasonably benign. And, even then, I’m becoming increasingly concerned that as banks’ real earnings rise, regulators will be more punitive in fines for past transgressions, and demand bigger buffers of unproductive capital, more spending on risk analysis, compliance and so on, all of which will have the effect of reining back the earnings growth.
For these reasons, I can’t see a big uplift in Lloyds’ earnings rating in the near future.
Another valuation measure — a more important one for banks in many people’s eyes — is the price-to-book (P/B) ratio. On this measure, too, I think Lloyds’ current rating is well up with events.
Lloyds trades on 1.5 times tangible book value. That’s a far richer rating than its rivals, which all trade around book value.
To put things into an historical context, UK banks averaged a P/B of 2.1 in the 20 years leading up to the financial crisis. That was a period of massive credit expansion, on the back of which banks made hay, turbo-boosted by high leverage.
In the future, even after the banks have worked through the continuing hangover of 2008/9, I can’t see a UK-focused bank, such as Lloyds, being afforded a P/B of much above the current 1.5 by the market. While it’s true that Lloyds’ book value has begun to tick up recently, the rate is very modest and there are no expectations for it to accelerate any time soon.
To my mind, then, Lloyds is fully valued at the present time, and I see little scope for a major re-rating of the shares in the coming year. Hence, I’m not backing the Black Horse to come home as one of the leaders of the field in the 2015 FTSE 100 Performance Stakes.
