VALUE INVESTING
Topping Up On Lloyds

By Stephen Bland (TMFPyad)
September 19, 2003

I took the opportunity a few days ago, following my sale of Royal & SunAlliance (LSE: RSA)(NYSE: RSA) as described in last week's article, to increase my holding in Lloyds TSB (LSE: LLOY)(NYSE: LYG). I got a price of about 418p, because I felt that the recent price weakness was unjustified on the fundamentals. I now have about three quarters of my total funds invested in Lloyds, my only other holding being a very small play in Anglo Pacific (LSE: APF) bought in early May at about 36p. This leaves me with a fair chunk of cash. I did not put all the proceeds from Royal into Lloyds, wanting to keep some back in case anything else interesting comes along.

Lloyds is not a pyad share, it is just a very cheap share compared with the other major clearing banks. It was cheap at 500p and a bargain at 400p. When it got down to 300p they were practically paying investors to buy it. My opinion is that it is almost indistinguishable from the competition yet it trades on a yield that is higher by a sizeable differential.

Personally I see little difference between the big banks. Is there anything to choose between Barclays (LSE: BARC)(NYSE: BCS) for example and Lloyds? No. A bank is a bank. So why do they trade on vastly different yields? Answer, no reason except the vagaries of human nature that cause the imbalances of share valuation upon which value players capitalise.

My point is that commentators and investors will always find reasons why Lloyds should be cheaper, until it no longer is, then they will spend their time telling you why some other bank should be cheaper or maybe deserves to be dearer and so on. It is again human nature that people will, ephemerally, find reasons for anything happening in the market and will be quite capable of writing the exact opposite later if it appears to suit the changed circumstances.

Ignore this stuff and make up your own mind. Ask yourself if the reasoning for Lloyds being cheaper arise from the "explanation compulsion" that grips the press and many individuals. People feel compelled to explain everything rather than taking my view that the explanations are frequently the effect, not the cause of market valuations.

One constantly expressed fear for Lloyds investors is that the company may cut the dividend, perhaps so that its yield falls to similar level to the other banks. It is a fair point, dividends are always at risk, but I think it a risk worth taking.

The current total dividend of 34.2p per year, if not cut, yields 7.8% at 438p. This alone makes the share an attractive investment for those prepared to take the risk. Held for any length of time, the likelihood of something good happening to an investor (in the sense of total return including dividends) is very high. Combined with, in my view, limited downside risk is what comprises a good value play.

It is extremely unlikely that over time Lloyds will continue to yield at this level because it is so out of line with almost any other large FTSE 100 constituent, with the exception of some of the regulated utilities. In fact its dividend might be considered to be even safer than some of the utilities. This situation is just too unlikely for one of the most well-known businesses in the country. It is unstable and consequently something will have to give. I see only two possibilities that will lower the yield, a dividend cut or a price rise. I am banking on the latter.

The author holds shares in Lloyds TSB and Anglo Pacific.