Views on Lloyds Banking Group (LSE: LLOY) have become increasingly polarised since the UK voted to leave the EU. In City analyst research, on private investor discussion boards and among writers here at the Motley Fool, opinion is sharply divided.
My Foolish friends Peter Stephens and Kevin Godbold have argued a bull view and bear view, respectively — and both articles are well worth reading, whether you’re sitting squarely on the fence, or leaning one way or the other.
Pointing to Lloyds’ low earnings multiple, Peter writes that “its shares offer a major upward rerating opportunity as well as a wide margin of safety. This reduces Lloyds’ risk profile and means that the dangers facing the UK economy may be more than adequately priced-in”. On this basis, Lloyds remains Peter’s “#1 stock”.
In contrast, Kevin argues that Lloyds’ low earnings multiple (and high dividend yield) at the current stage of the economic cycle “are unattractive and signal danger ahead for investors”. As such, his view is that “it’s time to give up on Lloyds because there are better-growing and dividend-paying options available”.
Known knowns
Lloyds’ earnings rating is undoubtedly ‘cheap’ based on the analyst consensus forecast. The price-to-earnings ratio for 2017 is 9.5 — well below the FTSE 100 long-term historical average of 14. A consensus forecast dividend yield of 5.7% also spells ‘value’.
The analyst forecasts for Lloyds have fallen since the Brexit vote — earnings by 20% and the dividend by 30%. However, while these revisions are based on ‘known knowns’, such as the post-referendum Bank of England base rate cut from 0.5% to 0.25%, Brexit presents a host of ‘known unknowns’.
Known unknowns
If a recession and housing market slump were to materialise next year, even the current low-end analyst earnings forecasts for Lloyds would prove to be overly optimistic. According to renowned fund manager Neil Woodford, a housing market correction would also “shatter the consensual view that [Lloyds’] balance sheet is rock solid.”
In such a scenario, and with a protracted Brexit to follow, investors who have backed Lloyds over the past three years would very likely see their losses extend into long-term territory.
Of course, this deeply negative outcome isn’t the only possible scenario. The ‘known unknowns’ could play out in such a positive manner that even the current top-end analyst earnings forecasts for Lloyds prove to be overly pessimistic.
And this is the crux of the matter. Nobody really knows what lies ahead. Lloyds’ prospects are largely outside of its own control, and the macro-uncertainty leaves the outcome for the bank finely balanced between good, indifferent and bad.
Glass half-full or half-empty
In these situations where uncertainty is so extensive, the bull and bear positions seem less about differing interpretations of the same hard data and more about investor disposition. Glass-half-full folk are naturally inclined to be drawn to the potential opportunity, while glass-half-empty folk are naturally inclined to shy away from the potential risk.
I suppose, as an inveterate ‘miserable so-and-so’, I gravitate towards the latter camp. I was relatively optimistic about Lloyds’ prospects — particularly as an income stock — before the referendum, but the Brexit vote has rather hobbled my confidence in the Black Horse.
Having said that, I can see a place for Lloyds as a higher risk holding in a diversified portfolio, although, like Kevin, I believe there are plenty of stocks around with a more appealing risk-reward profile.
