There are many definitions of a growth stock. Some say they should deliver returns substantially above the market as a whole. Others are more cautious and believe merely above average capital returns are required.
I’m at the more ambitious end of the scale.
I think growth stocks should significantly outperform the wider market. If I was pushed to put a number on this, I’d say around 25% better.
Recent history
Since its inception in 1984, the average annual increase of the FTSE 100 has been 6.3%.
However, over the past five years, it’s risen by ‘only’ 9.4%. With such a low bar, it’s not surprising that 51 current members of the index have gained more than this.
But during this period, Lloyds Banking Group (LSE:LLOY) shares have fallen 24%.
Assuming the Footsie repeats its historical performance, for the bank to be considered a growth stock, I reckon it needs its stock market valuation to increase by at least 30%, during 2024.
Let’s see if this is likely.
Accounting value
Lloyds’ current market cap is £28.6bn. A 30% increase would lift this to £37.2bn.
The bank’s latest balance sheet discloses a book value (assets less liabilities) of £45bn.
On a net assets basis, even a £37.2bn valuation would appear to undervalue the bank.
But not all sectors are valued equally. It’s therefore necessary to make comparisons with others in the same industry.
If Lloyds did attract this higher valuation, its price-to-book ratio would be 0.82 — the same as HSBC‘s, but far bigger than those of NatWest Group (0.53) and Barclays (0.32).
A potential problem
However, HSBC generates a smaller proportion of its income domestically (22%) than the others.
In contrast, Lloyds is almost totally reliant on the UK for its earnings, where it has 20% of the mortgage market.
And I think that’s why it fails to attract a higher valuation.
The economy has struggled since the pandemic. And although Gross Domestic Product is expected to increase in 2024 and 2025, very few economists are forecasting growth to be close to its long-term trend rate of around 2% per annum.
The higher interest rate environment is also adversely affecting the housing market. And it increases the chances of borrowers defaulting on their loans.
Prospects
But it wasn’t that long ago — just before Covid closed the UK economy, in early 2020 — when Lloyds was valued at over £37bn.
Prior to this — in 2019 — the bank reported an underlying profit of £7.5bn.
Now, the analysts’ consensus forecast is for 2023 earnings of £7.6bn. Although this is expected to fall to £7.3bn, in 2024.
Overall, I believe a strong case can be made for Lloyds to be valued more highly.
But I suspect its UK exposure — and lack of earnings growth — means it won’t meet my definition of a growth stock. I think some others in the Footsie will do better in 2024.
However, even if it did soar by more than 30% this year, I don’t think this would be sustainable due to the disappointing earnings outlook. A genuine growth stock should repeatedly outperform the market, and not just for 12 months.
But it’s not all bad news. The bank’s lacklustre share price performance means the stock’s currently yielding 6.2%, compared to the average for the FTSE 100, of 3.9%.
