After hitting a low of 56p on February 11, shares in Lloyds Banking Group (LSE: LLOY) have soared by 27% to 71p in just one month.
This brings the share price very close to the government’s 73.6p breakeven level. If the stock rises above this level for any length of time, the Treasury is expected to resume selling its stake in Lloyds, which currently stands at 9%. Gains above the 73.6p level would also increase the chance that the Chancellor’s promised discounted offering to retail investors would go ahead later this year.
This leaves private investors facing a dilemma. Are Lloyds shares still a buy, and is it worth paying more than 73.6p if they continue to rise?
Decent value
Lloyds shares currently trade on a 2016 forecast P/E of 9 with a potential yield of 6.3%. In my view this is probably reasonably good value. Indeed, I’d probably be happy to pay anything up to 75p.
However, if the shares trade above 75p or so for any length of time, we can probably expect the government to start selling its shares again. As happened previously, this supply of new stock to the market would probably limit any further price gains. This is why I wouldn’t pay more than 75p for Lloyds shares while the government still has a stake in the bank.
If the shares rise above this level, I would simply sit back and wait for another market dip. I’d also consider signing up for the government’s discounted share offer, if it takes place.
As a reminder, the Chancellor has proposed a sale of stock to retail investors at a 10% discount to their market value. The proposed deal also includes a promise of additional free bonus shares to investors who hold the stock for a minimum length of time.
Dividend risks?
Overpaying for an investment is one of the main causes of poor returns. Even the best stock is only a buy if the price is right.
The banking sector is getting back to normal, but has not yet demonstrated that it can generate meaningful growth. Lloyds is no exception. According to the latest forecasts, adjusted earnings per share are expected to rise by just 1.5% to 7.7p in 2017.
This makes me question market expectations for Lloyds’ dividend. After the bank surprised investors with a 2.25p dividend for 2015, City analysts bumped up their forecasts for the bank’s 2016 and 2017 dividends.
The latest consensus forecasts suggest that Lloyds will pay a dividend of 4.3p in 2016 and 5.1p in 2017. These equate to a payout ratio of 57% of earnings in 2016 and 66% of earnings in 2017. These payout ratios seem quite high to me, given the limited outlook for earnings growth.
Lloyds shares shot higher following the bank’s recent results, as investors celebrated the return of a meaningful dividend payout. But this sentiment could quickly reverse if the market starts to doubt Lloyds’ ability to deliver sustained dividend growth.
