Was I wrong about the Lloyds share price all along?

Does this mean I should turn bullish on Lloyds Banking Group plc (LON: LLOY)?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

I’ve been writing only bearish articles about Lloyds Banking Group (LSE: LLOY) for a few years. It occurred to me at the end of 2013 that the rapid upswing in the share price relating to the firm’s operational recovery could be over.

So far, that theory has played out because there’s been no big surge higher for the share price from its level of around 82p five years ago, despite a dramatic recovery in earnings.

A shrinking valuation

I’ve maintained the argument that the stock market would be likely to gradually mark down Lloyds’ valuation as earnings grow because of the firm’s cyclicality. Lloyds is a commodity-style enterprise that relies on the fortunes of its customers, such as individuals and companies, in order to thrive. If Lloyds’ customers do well, Lloyds will do well. But if the economy takes a dive and Lloyds customers begin to struggle, I reckon its profits will plummet along with the share price and dividend.

It was well-known, one-time US fund manager Peter Lynch who alerted me to the idea that the valuation indicators of banks and other cyclicals are best interpreted differently than we usually do for a trading company. He argued in his book, Beating the Street, that for the big banks and other cyclical enterprises, a high dividend yield and a low price-to-earnings (P/E) multiple can be indicators of POOR value when they come after a sustained period of robust and rising profits. He reckons that the low valuation is the market’s way of trying to adjust for the probability of lower earnings down the road when the economic cycle turns downwards.

I reckon we are seeing that scenario with Lloyds now. But what will happen next? Lynch suggested that there would be a big risk to the downside because big profits usually cycle down to smaller profits in the end. When that happens, the share prices of cyclical firms tend to plunge, despite the way the market has been trying to peg the valuation.

This is what I want to see

But have I been wrong about Lloyds’ share price all along? After all, many commentators disagree with my stance. They point out the ‘value’ displayed by those tasty-looking indicators and the stock is up around 13% this year already, close to 56p. Maybe we’ll see a sustained rise that takes the shares beyond the summer 2015 peak around 87p? Maybe, but I’m sceptical about that. City analysts are predicting flat earnings for 2019, which lends more weight to the ‘peak earnings’ argument, as I see it. Indeed, the next move in earnings could be down.

And that’s what I’m waiting for with Lloyds. I want to see earnings plummet before I’d entertain going bullish on the shares again. If earnings fall off a cliff, causing the P/E multiple to shoot up, I’ll have much more confidence in buying the fallen share price. Right now, we only have a weak share price with earnings remaining robust. Lloyds is just too dangerous for me, and I certainly won’t be buying the shares on the strength of the dividend alone. I’m holding fast with my bearish view on Lloyds for the time being.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

How much does an investor need in a Stocks and Shares ISA to earn £1,000 a month in passive income?

A Stocks and Shares ISA's a valuable asset for investors. Not having to pay dividend tax can be a big…

Read more »

Investing Articles

9% dividend yield! Could buying this FTSE 250 stock earn me massive passive income?

Assura looks like an outstanding stock for dividend investors to consider. But is the 9% dividend yield the passive income…

Read more »

Man putting his card into an ATM machine while his son sits in a stroller beside him.
Investing Articles

Why I think this month could be critical for the Lloyds share price!

Our writer explains why he thinks the bank's 2024 results will have a significant impact on the short-term direction of…

Read more »

British Pennies on a Pound Note
Investing Articles

This former penny share has soared 168%. Is the best yet to come?

When Christopher Ruane saw a penny share as a potential bargain last year, he was spot on. So having not…

Read more »

Mature couple at the beach
Investing Articles

£20k in an ISA? Here’s how it could generate £1 of passive income every hour — forever

With a long-term approach, Christopher Ruane explains how an investor could aim to earn a pound per hour in passive…

Read more »

One English pound placed on a graph to represent an economic down turn
Investing Articles

FTSE shares: overpriced or still a bargain?

Christopher Ruane reckons a storming FTSE 100 performance of late doesn't tell us much about whether there are still possible…

Read more »

Blue NIO sports car in Oslo showroom
Investing Articles

Would an investor have made money investing £2k in NIO stock 5 years ago?

Our writer looks at how NIO stock has performed over recent years and weighs the bull and bear cases as…

Read more »

Young woman working at modern office. Technical price graph and indicator, red and green candlestick chart and stock trading computer screen background.
Investing Articles

5 steps to start buying shares with £5 a day

In a handful of steps, our writer explains how someone new to the stock market could start buying shares for…

Read more »