Intuitively, you’d think the giant companies of the FTSE 100 would have relatively high share prices. And for the most part that’s true. You’ll even have to pay over £100-a-pop for a couple of companies (AstraZeneca and Spirax-Sarco Engineering).
However, there are a few blue-chip names that can be bought for less than a quid. Rolls-Royce has traded above and below that level in recent weeks. But Lloyds and ITV are currently firmly ensconced in sub-£1 territory.
I’ll leave ITV for a future column, and focus today on Lloyds. Priced at 45p as I’m writing, I reckon its shares have considerable upside potential. Indeed, I think there’s a good argument the price could double.
Harking back to the financial crisis
Lloyds has been a stalwart of the FTSE 100 ever since the index was established in 1984. The reason it’s a ‘penny stock‘ today goes back to the shedloads of new shares it had to issue as a result of the great financial crisis and recession of 2008-09.
It went into that period with less than 6bn shares in issue and came out of it with more than 60bn.
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Sleight of hand
If you’re wondering why NatWest — the former Royal Bank of Scotland and biggest UK bank pariah of the financial crisis — isn’t also a penny stock, the answer’s simple. As well as the name change, it has performed a sleight of hand called a share consolidation.
Shareholders were given one share to replace every 10 they owned and the price went from 20p to 200p in the blink of an eye — a price “more appropriate for a company of the group’s size in the UK market,” as the board put it.
A more valuable business today
Lloyds, I think to its credit, hasn’t veiled the past with a share consolidation and name change.
At the time of its 2007 results, its share price was 430p and its market capitalisation was around £25bn. The share price may now be about a tenth of that level, but the huge increase in the number of shares means its market capitalisation is actually higher at £31bn.
In other words, the market sees Lloyds as a more valuable business today. The same can’t be said of NatWest, despite its more ‘respectable’ share price.
Return on equity
In the aforementioned 2007 results, Lloyds made a 25% return on equity (ROE). However, those days are long gone. For banks — as the financial crisis exposed — a 25% ROE is only achievable with dangerously high financial leverage.
Lloyds’ target ROE for 2022 is less than half that of 2007. However, this level of return still represents substantial profits and decent dividends. And, of course, at lower risk — the aim of the post-financial-crisis banking reforms.
Lloyds is forecast to make a profit of £4.5bn this year and to pay shareholders ordinary dividends totalling £1.6bn. Analysts also reckon it’ll have a further £1.6bn of surplus cash, and most expect this to be used for share buybacks.
At 45p a share, Lloyds is priced at a modest 7.5 times forecast 2022 earnings with a prospective dividend yield of 5.2%.
A price-to-tangible net asset value (P/TNAV) ratio of 0.78 is a further indicator of potential good value. It means investors are currently paying just 78p for every £1 of Lloyds’ assets.
Why the share price could double
For a spell before the succession of negatives of recent years — Brexit nervousness, the Covid pandemic (and snap-recession), and current fears of a cost-of-living crisis — the market valued Lloyds at a P/TNAV in the region of 1.5.
I have little doubt it will do so again at some point in the future. A time will come when the economic outlook (or market perception of it) and investor sentiment are brighter.
Based on Lloyds’ current TNAV, the share price would double if the market again valued the business at a P/TNAV of around 1.5. And, as I say, I think it will do so at some point.
However, I’m equally certain Lloyds will face another recession or crisis in due course. That could come sooner or it could come later.
I think Lloyds offers good value when it’s at a P/TNAV of below 1. But I’d have to be prepared for some volatility. Because the bank’s highly synched to the UK economy, there are inevitably ups and downs in its valuation through the economic cycle. Buying when the P/TNAV is low could give me some degree of insulation.