It has been a great 12 months for shareholders in Lloyds (LSE: LLOY). Over the past 12 months, Lloyds shares have moved up by 65%. That period also saw earnings per share grow 11% and the ordinary dividend per share increase 15%.
Clearly, the City has warmed to the investment case. Having sold for pennies for well over a decade, Lloyds shares have now breached the psychologically powerful pound level. They are up 180% over the past five years.
But have they gone too far too fast – or could there be more fuel in the tank?
Ongoing business growth opportunities
Although Lloyds shares have zoomed over the past five years, that reflects a much improved business performance.
Last year, for example, profit after tax came in at £4.8bn. The equivalent number for 2020, five years previously, had been a far lower £1.4bn.
That was severely dented by pandemic-era provisions, but even the unaffected prior year (2019) number of £3.0bn was markedly lower than last year’s performance.
That helps explain why Lloyds shares have done so well.
Profit after tax has more than tripled over five years. Set against that, the five year share price growth of 180% — meaning it has less than tripled – looks less remarkable.
Where has that earnings growth come from?
Partly it reflects Lloyds’ ongoing strength in lending. Being the nation’s largest mortgage lender has been lucrative at a time of high interest rates, while loan defaults have stayed at manageable levels.
Some of the growth has also come from Lloyds’ move into being a large-scale residential landlord. This could help it expand its earnings streams.
But that sideline is not really decoupled from the core business in the sense that, if a property crash was to hurt Lloyds’ core banking business, it might also mean bad news for the value of its own property portfolio, even if tenants kept paying rent. That is a risk that makes me uncomfortable.
Time to buy?
Still, Lloyds has undeniably been doing well.
However, at 15 times earnings, has the share price got ahead of itself?
Not only is that price-to-earnings (P/E) ratio above some rivals such as Natwest (which sits on a P/E ratio of 9), I also have some concerns about another common valuation metric for bank shares.
Lloyds’ current price-to-book ratio of around 1.3 means the share is selling for well above book value.
Such a valuation could suggest that the share is now overpriced and the rally of recent years has been overdone.
More positively, it can be interpreted as a vote of confidence by the market that Lloyds has ongoing growth potential. As I outlined above, I think that could well be true.
Still, that share price and valuation make me uncomfortable. Given its huge mortgage book, any property market downturn is a significant risk for Lloyds especially if it pushes loan defaults up a lot. The current UK economic outlook is not particularly strong, so I see this as a concern for a long-term investor like myself.
Without a much bigger margin of safety than the current price offers me, I am unwilling to buy Lloyds shares for now.
