Has Lloyds Banking Group PLC Risen Too Far Too Fast?

Should you Lloyds Banking Group PLC (LON: LLOY) after recent gains?

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Over the past 12 months Lloyds’ (LSE: LLOY) shares have risen by around 16%, outpacing the wider FTSE 100 by 9% and the rest of the banking sector by 13%. 

These gains have been driven by Lloyds’ upbeat first-quarter results and the Tory election win. 

What’s more, over the past five years Lloyds’ gains are even more impressive. Since May 2010, Lloyds has outperformed the FTSE 100 by 19% or approximately 4% per annum. 

But after these impressive gains, the big question is; has Lloyds risen too far too fast? Should investors avoid the bank after recent gains? 

Dividing the City

Lloyds continues to divide opinion in the City. On one hand, the bank is expensive. It trades at a significant premium to its net tangible asset value, which currently stands at 55.8p per share. 

That’s a price to tNAV figure of 1.6. Many of Lloyds domestic and international peers trade at a price to tNAV figure of around 1. 

However, there are plenty of analysts that believe Lloyds deserves this lofty valuation. 

Balance sheet strength 

Since the financial crisis, banks have tended to trade at, or around their tNAV per share. The reason for this is simple; the market doesn’t trust the value of assets on bank balance sheets.

You see, there is some discretion as to how banks calculate the value of loans and other financial assets, which can lead to the overstatement of assets. As a result, the market prices in a margin of safety.

It looks as if the opposite is true for Lloyds. The market has placed a premium valuation on the bank, which indicates that investors have started to regain trust in Lloyds’ balance sheet as the bank’s restructuring yields results.

Increasing return

Lloyds is also outperforming its peers on many other metrics. 

Lloyds’ return on equity (ROE) — a key measure of bank profitability — hit 16% during the first quarter of this year, while many of the bank’s peers reported ROE figures in the low-teens.

Management is targeting a ROE of 13.5% to 15% by 2017.  In comparison, Barclays is targeting a ROE of 12% and HSBC is targeting a ROE of “more than 10%”.

Income play 

Along with one of the highest ROE figures in the industry, Lloyds is an attractive income play. Moreover, the bank looks cheap on a P/E basis. 

City analysts believe that Lloyds’s shares will support a dividend yield of 3.2% this year. Payout growth of 44% is expected during 2016 with the average analyst estimate predicting a full-year 2016 dividend payout of 4.2p. Some analysts are predicting a payout of as much as 5p per share for 2016 — a yield of 5.7%. 

Lloyds currently trades at a forward P/E of 10.7.

The bottom line

Overall, Lloyds’ recent gains have left the bank looking expensive on a price to tNAV compared to its domestic and international peers.

But in many respects, Lloyds deserves this higher-than-average valuation.

Indeed, Lloyds’ ROE is one of the best in the industry, the strength of the bank’s balance sheet is improving and Lloyds is planning to return an increasing amount of cash to investors over the next few years.  

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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