During 2013, I’ve looked at most shares in the FTSE 100 and graded them against these five quality and value indicators:
- Dividend cover
- Borrowings
- Growth
- Price to earnings
- Outlook
Some companies scored highly against the “business quality” indicators of level of borrowings, earnings growth record, and outlook. Others scored highly against the “value” indicators of dividend cover and price-to-earnings ratio (P/E).
Quality and value in harmony
However, the most promising investment opportunities scored well on both business quality and value indicators.
In this mini-series, I’m revisiting some of the highest-scoring shares to look at events since the original article and to assess the quality of the investment opportunity now. Some of these high-scoring firms could be investment winners for 2014 and beyond so, today, I’m revisiting UK-focused financial services and banking company Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US), which scored 20 out of 25 in May.
Improving figures
In its recent third-quarter interim statement, Lloyds reckoned it is well on the way to becoming a better, simpler, lower-risk bank, capable of delivering the products its customers need and the strong, sustainable returns expected by shareholders.
The figures seem to back that assertion up; underlying profit is up 136% on a year ago at £4,426 million and the firm’s net interest margin (interest earned minus interest paid) continues to improve, with the full-year figure expected to stand at 2.11%.
Financial strength
Evidence of Lloyds’ derisking strategy shows in the progress made on some key measures. For example, the loan-to-deposit ratio is down to 114% from 121% a year ago – the lower the ratio, the less the bank relies on short-term wholesale funding, which can dry up as we’ve seen in the recent credit crisis.
The risk-based measure, the tier 1 capital ratio, is up to 13.5% from 12% a year ago, and the “back stop” measure, the fully-loaded leverage ratio, which compares equity to total assets, is up to 4% from 3.8%.
During the period, Lloyds has continued selling off non-core assets and, naturally, the total-assets figure is down, having fallen to £870 billion from £934 billion last year. With a net-tangible-assets figure of about 51p, Lloyds’ shares are now trading above asset value. That’s quite normal for banks when profits rise through the cycle; I think banks were trading at about four times book value in the last boom.
Total-return potential now
In May, Lloyds’ shares tempted with their remaining recovery potential. Since then, the share price is up 21% to 75p. There’s even progress towards restoring that other pillar of investor total returns, the dividend, with the CEO saying “We have now commenced discussions with the regulators regarding the timetable and conditions for future dividend payment.”
I’m encouraged by the firm’s recent trading progress, positive outlook, and liabilities-management. The valuation remains similar to what it was in May with a forward P/E of 11 sitting well against expectations of 30% growth in earnings and a 3% dividend yield for 2014.
My “business quality” and “value” indicators remain unchanged: dividend cover 5/5, borrowings 2/5, growth 4/5, P/E 4/5 and outlook 5/5, for an overall score of 20/25.
