Patience is one of the key attributes of a successful investor. The likes of US master Warren Buffett have been known to wait years for the right company at the right price.
Now, while buying stocks at a fair price will tend to pay off over the long term, we all love to bag a real bargain.
Today, I’m going to tell you the price I believe would put Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) in the bargain basement.
Asset valuation
If I had to use just one financial metric for valuing banks, it would be price-to-tangible net asset value (P/TNAV). If you can buy £1 of assets for less than a quid, you’re on to a good thing — provided, of course, that the assets are accurately valued and can provide a productive return.
It seems almost bizarre now that when I was highlighting the value in Lloyds for Motley Fool readers back in December 2011 the share price was 23.6p against a TNAV of 58.3p — a P/TNAV of 0.4. Put another way, the market was offering investors the opportunity to pay just 40p for every £1 of Lloyds’ assets.
Sure, we all knew there were further asset writedowns to come, but 60p in the pound of worthlesness seemed way too pessimistic to me!
The situation today is very different. Lloyds’ share price is 75p against a TNAV of 50.7p — a P/TNAV of 1.48. In other words, the market is now asking investors to pay £1.48 for every £1 of the bank’s assets.
At what price a bargain?
I don’t expect to see Lloyds trading at a P/TNAV of 0.4 again in my lifetime. That was an exceptional rating during an exceptional period for financial markets.
Assuming we are now moving into more temperate economic climes, what valuation would put Lloyds in the bargain basement for me today?
Well, on a P/TNAV basis, Lloyds at 1.48 is easily the most expensive of the Footsie’s ‘Big Five’ banks, with the next most richly-rated being Standard Chartered (1.23), followed by HSBC (1.11), Royal Bank of Scotland (0.93) and Barclays (0.80).
However, I’m going to use as my benchmark Warren Buffet’s favourite bank and largest holding Wells Fargo. Like Lloyds, the US bank is a traditional lender with a sizeable share of its home mortgage market.
In the years before the financial crisis, Wells Fargo was delivering a super-efficient return on assets — for a bank — of about 1.7%, and was able to make a very decent return on equity with relatively modest financial leverage (a low assets/equity multiple). For this, the market was happy to pay a P/TNAV of around 3.
Post-financial crisis, Wells Fargo’s return on assets is heading back towards 1.7%; it’s currently up to over 1.4%. Meanwhile, the current P/TNAV is 2.22 — a good discount to the historical 3.
Now, Lloyds’ return on assets in the years before the financial crisis was 0.85% — half that of Wells Fargo. So, I reckon a rating of half the current P/TNAV of the US bank would put the Black Horse in tasty territory. As things stand, that translates into a P/TNAV of 1.11 for Lloyds, and a share price of just over 56p.
