Lloyds Banking Group (LSE:LLOY) shares have been, according to ChatGPT, a “strong performer” over the past five years. This is undoubtedly true. But when I asked the software how much a £10,000 investment made in December 2020 would be worth five years later, it gave me a figure that it said “may or may not” include the impact of reinvesting the dividends received.
To be honest, that’s not a very useful answer because whether someone decides to bank the dividends — or use them to buy more shares — can have a dramatic impact on the value of a portfolio. Let me illustrate.
Scenario 1 – spend the money
Since December 2020, Lloyds has paid dividends of 12.12p a share. This means a £10,000 investment made five years ago, would have earned £3,472 in payouts. At the same time, the initial lump sum would now be worth £27,736.
Overall, that’s a gain of £21,208, or 212%.
Scenario 2 – reinvest the dividends
Alternatively, if the payouts had been used to buy more shares at the end of the week in which the dividends were paid, the initial £10,000 would have grown to £35,733.
That’s an increase of £25,733, or 257%.
These two examples demonstrate the power of compounding. It also illustrates, in my opinion, the weakness of artificial intelligence software. I reckon there’s no substitute – at least for the time being – for research undertaken by humans.
So does this human reckon there’s a compelling case to be made for buying Lloyds shares?
Not cheap
To be honest, I think the bank’s stock is looking expensive, especially for a business that’s reliant on a shaky UK economy for nearly all of its income.
The last time they were changing hands for more than £1 (adjusted to reflect subsequent rights issues and share consolidations) was in 2008, just before the global financial crisis. Today, the share price isn’t far off this level.
Back then, Lloyds TSB (as it was known) had just published its 2007 annual report. This disclosed a post-tax profit of £3.29bn. At the time, its shares traded on 8.1 times earnings. By comparison in 2024, it reported a profit after tax of £4.48bn. This means the stock has a price-to-earnings ratio of 15.1 times historic earnings.
According to McKinsey & Company’s most recent global banking survey, the average multiple for the industry is 8.4.
Looking ahead
But analysts are forecasting some very impressive growth over the next three financial years. By 2027, they’re predicting a profit of £6.82bn and earnings per share of 11.3p. If realised, these would represent 52% and 179% improvements respectively on 2024’s numbers. I reckon this would be a brilliant performance.
However, I can’t see this happening. Remember, earnings in 2024 were ‘only’ 36% higher than they were 17 years earlier.
Much of the improvement appears to be predicated on a net interest margin improvement from 2.95% in 2024 to 3.39% by 2027. This is against a backdrop of an anticipated cut in borrowing costs. I know Lloyds makes more on its loans than it pays on deposits, but I don’t see it being able to grow its loan book sufficiently to offset the double whammy of increased competition and falling interest rates.
On this basis, I think there are better opportunities to explore elsewhere.
