Last September, the Lloyds Banking Group (LSE: LLOY) share price bottomed out just below 25p. So today’s near-37p price represents a fair advance over a period of just under five months.
But scope back a full year, and Lloyds was about to tip into its sharp plunge from around 57p. So the stock has yet to regain even half the ground it lost when the pandemic hit the markets.
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Earnings set to bounce back
Meanwhile, City analysts expect both earnings and the shareholder dividend to bounce back by percentages measured in three figures this year. And it’s difficult to make a case for the valuation looking expensive.
For example, the price-to-asset value is just over 0.5. And the forward-looking earnings multiple for 2021 is just below 11. On top of that, if the dividend payments arrive as predicted this year, the forward-looking yield is around 4.4%.
If economies continue to recover because vaccines beat back the pandemic, I think there’s potential for further business recovery at Lloyds. And the stock will likely anticipate that recovery by moving higher first. But because Lloyds runs such a cyclical business, it’s sensitive to the general economic outlook. If the recovery in the economy stalls, I think we’ll see evidence of the deteriorating outlook in Lloyds share price.
As well as upside potential, I reckon the rise in the Lloyds share price has increased the downside risks for shareholders. And because of the pandemic, we’ve recently seen how fast Lloyds business can decline if the economic conditions aren’t just right.
Because of its cyclicality, I’d never aim to make Lloyds shares a long-term holding in my portfolio. I’m expecting the business and the stock to behave in a similar way it did following the previous big economic shock. Following that credit crunch, the stock bottomed in the spring of 2009. However, by September 2010, the share price was near the top of a trading range it couldn’t exceed.
The possibility of a shrinking valuation
For almost a decade, earnings edged higher. But instead of the share price rising to accommodate that growth, the valuation contracted instead. Indeed, by traditional valuation measures, Lloyds looked compelling. However, the next big move was the catastrophic collapse in earnings, shareholder dividend and share price because of the pandemic.
If it hadn’t been for the pandemic, my guess is Lloyds would still be moving sideways. Meanwhile, its valuation would probably have been gradually contracting while the market waited for the arrival of the next general economic down-leg in the cycle.
So right now, I see limited, shorter-term upside potential for Lloyds shareholders followed by lots of downside risk (as before). To me, the inherent cyclicality in Lloyds’ business is the overriding consideration when evaluating the stock.
I’ve been banging on about this theme regarding the London-listed banks for years. But my approach has saved me from making some big investment mistakes in the sector. Of course, I could be wrong. Perhaps this time it’s different. We’ll find out more with the full-year results report due on 24 February.
