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Why Lloyds Banking Group plc could be the bargain of the decade

Image: www.moneybright.co.uk Licence: creativecommons.org/licenses/by/2.0/

Beneath its legacy issues, Lloyds (LSE: LLOY) has made tremendous progress since the financial crisis, transforming itself into a UK-focused, simple, low-risk retail and commercial bank.

It now boasts a host of best-in-class financial metrics, from core tier 1 capital to an excellent cost-to-income ratio. Dividends are up-and-running again and HM Treasury’s bailout stake in the bank is down to below 5%, with a full exit expected to be completed this year.

Brexit uncertainty

But despite the progress, Lloyds’ shares are languishing below the level they were at before the EU Referendum, while those of global bank HSBC and many other multinational companies listed on the FTSE 100 have soared.

With uncertainty about Brexit likely to persist through the two-year negotiation period, and perhaps for some time after, it’s not unthinkable that Lloyds’ shares could bump around at a depressed level for quite a considerable time.

I’ll tell you shortly why I think this prospect should actually lead you to embrace rather than shun Lloyds’ shares today. But first a look at the current state of play.

Short-to-medium term

In addition to the Brexit uncertainty, there are a number of other short-to-medium-term issues that are likely to keep market sentiment towards Lloyds mixed at best.

PPI insurance claims are set to run through to a mid-2019 cut-off and while Lloyds believes it’s made its last major provision, it’s not at the finishing line yet. Of course, in the longer term, the bank will benefit from putting this costly legacy issue behind it.

Later this year Lloyds is expected to announce a three-year business plan designed to protect it from record-low interest rates, which are a dampener on profit margins. Again, we probably have to look to the longer term for a period of rising interest rates in which banks’ profits boom.

Finally, I also believe that Lloyds acquisition of credit card business MBNA from Bank of America will be of great long-term benefit. However, the short-to-medium term prospect is a little uncertain, with some analysts questioning the advisability of the acquisition at what could be an unfavourable time to be buying in the bad debt cycle.

Long term

So, given the uncertainty created by Brexit and the other short-to-medium-term issues I’ve mentioned, why am I suggesting that Lloyds could be the bargain of the decade today?

Well, here’s the thing: while many would cheer if Lloyds shares doubled from their current 65p tomorrow, long-term investors should really be praying that the shares stay as low as possible for as long as possible.

This is true not only for those building up a stake in the company through regular investment, but also for those making a single lump-sum purchase today and intending to reinvest their dividends.

Even if Lloyds were to pay a 3.25p dividend for 2017 (below the City consensus of 3.5p) and didn’t increase the payout for five years (despite the bank’s progressive dividend policy), a buyer of 1,000 shares today would own 1,250 shares by the end of the five years, if the shares stayed at their current depressed level.

You’d be far better off in the long-run if the shares doubled after having spent five years in the doldrums than if they doubled tomorrow.

The patience of Buffett

While many investors are impatient to see their stocks rise, legendary investor Warren Buffett likes nothing more than to see a company whose long-term prospects he believes in languishing at a low price for however long he's buying shares or reinvesting dividends.

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G A Chester 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.