Lloyds Banking (LSE: LLOY) (NYSE: LYG.US) has been a star performer in recent months, as the market has responded very favourably to the start of its re-privatisation.
However, despite shares making good gains, I think that it has some way to go and believe that a gain of 11.3% is achievable.
For instance, Lloyds currently trades on a forward price-to-earnings (P/E) ratio of 14.7, using earnings per share (EPS) for the 2013 financial year.
However, the banking sector (to which Lloyds belongs) trades on a P/E of 16.4, meaning that Lloyds currently trades on a discount of 10.4% versus its sector. Indeed, were it to trade on the same P/E as its sector, it would have a share price of 85.4p.
This is 11.3% higher than the current share price but, when the strong prospects for Lloyds are taken into account, I believe that the bank deserves to trade on a premium to its sector.
Indeed, since the credit crunch, Lloyds has made excellent progress in restoring the strength of its balance sheet. It has reduced the size of its asset base, attempting to retain only those assets that require relatively little capital in exchange for relatively high returns.
As such, its balance sheet is in better shape than some of its UK counterparts (and many of its European counterparts) and it was interesting to note that Lloyds was not required to raise capital by the regulator recently, with it being deemed to have a sufficiently strong balance sheet with which to return to the private sector.
In addition, Lloyds continues to offer investors the prospect of relatively high returns on their equity. Indeed, return on equity is forecast to be around 10% this year. This is very impressive and, although it is still short of where Lloyds believes it can be over the medium to long term, it represents excellent progress during what remains a challenging time for the bank.
So, a narrowing of the current P/E rating discount versus its sector could see shares in Lloyds make gains of 11.3%. However, I believe that it could be worth more when the aforementioned improving balance sheet and return on equity figures are taken into account.
