Shareholders in Lloyds Banking Group (LSE: LLOY) have seen their stock rise by more than 50% since November’s vaccine news reignited the UK market. But, at around 44p, Lloyds’ share price is still well below the 60p level seen shortly before the pandemic begun.
Assuming the recovery continues, I think there’s a good chance the bank’s shares will return to 60p. In my view, Lloyds’ strong finances and improved profit outlook leave plenty of room for further gains.
Plenty of spare cash
The disruption caused by the pandemic last year meant Lloyds was required to account for a sharp increase in bad debts. The bank’s 2020 results included a £4.2bn impairment charge. This reflects expected losses from the whole pandemic, not just losses suffered last year.
Lloyds doesn’t seem to have had any trouble absorbing this sizeable accounting charge. At the end of 2020, the bank’s tangible net asset value had increased, from 50.8p per share in 2019, to 52.3p.
What this means is that Lloyds still generated surplus capital last year, despite the difficult circumstances. Banks use surplus capital to fund their dividends. For me, this is key to the investment case for Lloyds.
Dividend appeal
The events of last year seem to suggest Lloyds has a pretty strong balance sheet. The bank declared a small dividend for 2020 and is expected to make a much bigger payout this year.
If the bank maintains its strong balance sheet this year and no further problems emerge, I expect more generous payouts of surplus capital. If I’m right, then I think future dividends should support a higher share price for Lloyds.
For example, broker forecasts show a payout of 1.7p per share this year, giving a yield of 4%. In 2022, the dividend is expected to climb 35% to 2.33p per share, giving a yield of 5.4%. If this outlook stays unchanged, then I’d expect to see the Lloyds share price rise, as investors buy into this yield story.
Lloyds share price: a safe bet?
Of course, there are no guarantees any of this will happen. The big banks have run into problems before and probably will again one day. Bank accounting is complex, and history suggests that problems aren’t always detected until it’s too late.
Another concern is that Lloyds is already very large, with a big share of the UK market. In my view, the bank’s focus on mortgages and consumer lending means it could suffer long-lasting problems if the UK fell into another serious recession. Even if things go well, I don’t know how much larger the business can get.
However, these are known risks. I think Lloyds’ share price reflects most of these concerns and leaves room for growth. With the stock trading on just 10 times 2021 earnings and offering a 4% yield as we (hopefully) exit the pandemic, I’d be happy to buy the shares for my income portfolio.
