I sold my Lloyds (LSE: LLOY) stock recently because it trades too much like a ‘penny share’ for my liking.
Strictly speaking, it is not one as its market capitalisation is too big. But at just 52p a share, every penny it moves is nearly 2% of the stock’s value!
Additionally, several FTSE 100 stocks look much superior to it on my three key investment criteria. These are dividend yield, earnings and revenue potential, and undervaluation against peers.
Legal & General (LSE: LGEN) is one, so I bought more of it with some money from the Lloyds’ sale.
Earnings growth potential
Consensus analysts’ expectations are that Lloyds earnings will grow by 4.9% a year to the end of 2026. Earnings per share are forecast to increase 8.4% a year to that point. Return on equity is projected to be 11.5% by then.
For Legal & General, expectations are that its earnings will increase 22.9% a year to the end of 2026. Its earnings per share are forecast to rise 24.1% a year to that point. Return on equity is projected to be 33.7% by then.
A clear win for Legal & General in my view.
I also think there is less risk attached to it than to Lloyds. But it is not risk-free. One is a new financial crisis — also applicable to Lloyds. Another is that its 3.8 debt-to-equity ratio is higher than the 2.5 or so considered healthy for investment firms.
For Lloyds, earnings and profits may fall longer term as UK interest rates decline. Another risk is possible legal action for mis-selling car loans through its Black Horse insurance operation.
And the effects of these risks are amplified in stock price terms, given its sub-£1 valuation.
Valuation against peers
Lloyds’ price-to-book (P/B) ratio is 0.7, against its peer group average of 0.6. So, it looks slightly overvalued on this measurement.
Legal & General’s P/B is 3, compared to a peer group average of 3.5. So, it looks undervalued on the same basis.
But by how much? A discounted cash flow analysis reveals the stock is around 59% undervalued against its peers.
Therefore, a fair value would be around £5.85 a share, against the current £2.40. This is no guarantee it will ever reach that price, of course.
Another clear win for Legal & General here, I think.
Dividend yield
Lloyds’ 2023 dividend of 2.76p a share gives a yield on the current 52p stock price of 5.3%.
Legal & General’s 2023 dividend of 20.34p a share gives a yield on the current £2.40 stock price of 8.5%.
This difference in yields results in a huge divergence in returns over time, especially if the dividends are reinvested.
£10,000 invested in Lloyds at an average 5.3% will give me an investment pot of £48,866 after 30 years. This would pay me £2,517 a year, or £210 a month in dividends.
£10,000 invested in Legal & General at an average 8.5% will give me £126,925 after 30 years. This would pay me £10,308 a year, or £859 a month!
So, another huge win for the insurance group here as well, making three out of three.
Consequently, I am extremely pleased with my decision to buy Legal & General stock instead of Lloyds and would do the same today.
