The first few months of 2016 haven’t been kind to shareholders of Lloyds (LSE: LLOY). The bank’s share price has jumped around, first plunging to 56p in mid-February and then rallying to 73p, before sliding back down to 64p. All in all, year-to-date shares in Lloyds are down by 12.4% excluding dividends.
And there’s a chance that Lloyds’ shares could fall even further. No one really knows what the future holds for the markets, and any hint of a global economic slowdown could send the FTSE 100 and Lloyds charging lower.
However, contrary to popular belief, a lower share price could be good news for Lloyds’ existing shareholders and those investors who want to buy into the bank’s success story.
Be greedy when others are fearful
Shares in Lloyds may have fallen this year but the bank’s underlying business has continued to show a steady improvement.
For example, for the three months ended 31 March 2016, Lloyds reported an underlying profit of £2.05bn, unchanged from the year-ago period. The bank’s net interest margin, the difference between interest income generated and the amount of interest paid out to depositors, ticked higher by 10 bps to 2.75% from 2.64% as reported last quarter. Moreover, Lloyds’ cost-to-income ratio fell to 47.4%, down from 47.7% a year ago, return on equity came in at to 13.8% and Lloyds’ capital reserves expanded to 13%, from 12.8% at the end of last year. Even if these metrics don’t improve over the next 12 months, Lloyds’ earnings will still get a boost from the bank’s decision to buy back so-called enhanced capital notes, which will give the lender a £900m cash injection over the next four-and-a-half years.
It’s clear Lloyds’ underlying business is suffering from the same kind of slippage as its share price. Yet for the astute investor, the share price drop presents a great opportunity.
More attractive
If Lloyds’ share price drops another 15% to 20%, to the low 50s, investors will be able to acquire shares in a world-class banking institution for a rock bottom valuation. City analysts expect it to report earnings per share of 7.6p for 2016 and 7.8p for 2017. At a price of 53p per share, this would leave Lloyds trading at a forward P/E of 8.4 for 2016 and 8.2 for 2017.
And City analysts believe that Lloyds has the capacity to pay 10p per share to investors via dividends, excluding any special payouts during the next two years. At 53p this would translate into a dividend yield of 19% for the next 24 months— that’s a yield you’d be hard-pressed to find anywhere else.
The bottom line
So overall, Lloyds’ underlying business remains healthy despite the fact that the market seems to believe the Lloyds recovery is stalling. If the bank’s shares continue to fall, they could present a very attractive opportunity for the astute value investor. The dividend yield and valuation on offer here at lower levels may be too hard for some to pass up.
