I’ve been bearish about Lloyds Banking Group (LSE: LLOY) for several years and avoiding the share has done my portfolio no harm at all – so far.
However, we could be nearing the end-game with Brexit. Will the demise of all the uncertainty cause the stock to shoot up? Maybe rising interest rates will go on to help the company make more money from its banking activities.
Then there’s the looming end-date in August for PPI mis-selling claims. Perhaps putting that sorry business behind it will help the shares rise?
Cheap, cheap, cheap
Indeed, one of the chief attractions drawing many investors to the stock appears to be its apparent low valuation. As I write, the share price stands at 58p, which throws up a forward-looking price-to-earnings (P/E) ratio just over seven for 2020, and the anticipated dividend yield is around 6%. Meanwhile, the price-to-tangible-book-value figure comes in close to one, which is another indicator suggesting a modest valuation.
My guess is shareholders are in the stock to harvest the dividend yield. Maybe there’s the chance of a valuation up-rating down the line too. Or perhaps a higher interest rate environment will drive profits up and the share price will rise to reflect the growth.
But what if the opposite scenario plays out? In the Brexit debate, the Remainers have been saying for years that leaving the EU will likely plunge the UK into recession and financial Armageddon. If that happens, it seems unlikely interest rates would rise to control the growth of the British economy.
Optimistic shareholders
It seems to me a bet on Lloyds today is a punt on general economic growth and prosperity down the road because bank stocks tend to move up and down according to the underlying prosperity of the markets they serve. And it’s not just the share price that moves. Cash flows, profits and dividends tend to rise and fall as well.
Maybe those betting on Lloyds today favour the Leavers’ argument that there might be a short-term negative consequence from Brexit, but the long-term benefits will shine through in the end? All of that could benefit the economy, push interest rates up, and allow Lloyds to make bigger profits, thus driving up the share price.
I think the macroeconomic future of the country is unpredictable. And I don’t believe Lloyds is undervalued because of uncertainty over Brexit. The economy could go either way from here, and so could the profits Lloyds makes. And if its valuation does look low, the situation could be corrected in more than one way.
Skewed consequences?
Indeed, the P/E ratio could rise, perhaps to reflect a rosy outlook and an acceleration in annual increases in earnings. Equally, earnings could fall, which is another way of pushing up the P/E number. However, if earnings do fall, I find it hard to see that happening without the share price and the dividend following it.
So on balance, I see greater consequences from the downside risk than opportunity from the upside potential with Lloyds. I’m going to keep hanging out with the bear over this one.
