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5 Ways Lloyds Banking Group PLC Could Make You Rich

Lloyds

Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) has made investors heaps of money over the past couple of years. Here’s how it could make you even richer in future.

1) Because risk equals reward

The Lloyds share price is up 132% over the past two years. It is up 57% over one year, against just 3% for the FTSE 100 as a whole. You can’t expect a repeat of that pace of growth, but the earlier you buy into its stumbling recovery, the bigger your ultimate reward. There is no question that banking stocks are set to remain turbulent, as more bad behaviour is uncovered, and politicians and regulators take ever tougher action to clean up the sector. This is a high-risk way to invest your money, but as we have seen lately, it can be a highly rewarding one as well.

2) By defying low expectations

The market has cooled on Lloyds (again), following Monday’s surprise pre-close trading update, in which management admitted it won’t ask the regulator if it can resume the dividend until the second half of the year. Many analysts were hoping it would pay a dividend on its 2013 earnings. The statement also revealed that the bill for legacy PPI mis-selling has leapt another £1.8 billion, to nearly £10 billion. This twin disappointment overshadowed the rather nice news that Lloyds’ full-year underlying profits will be double that predicted by analysts. Lloyds is in tentative recovery, and there will be plenty more setbacks, but it is ultimately only going in one direction.

3) The business is getting there

Lloyds is on course to make an underlying profit of £6.2 billion for 2013, some £400 million higher than consensus forecasts and double its 2012 profit. It also expects to report a small statutory profit before tax for the 2013 financial year, and an estimated common equity tier 1 ratio of 10.3% at 31 December 2013. Again, it is a slow process. As it exits international markets, Lloyds is heavily exposed to the UK retail banking sector in general, and the housing market in particular. Rising property prices should help lift its profits, provided the UK recovery is sustainable, and isn’t brought low by emerging markets contagion. 

4) By becoming a normal bank again

Chancellor George Osborne would love to have sold off the government’s remaining 33% stake in Lloyds before the May 2015 election. Whether he manages it hangs in the balance right now. Management is doing preparatory work for a future sale of shares to the public, which would rid it of government influence, and help it behave like a normal bank again. Lloyds is also cleaning out the toxic terrors in its past, with impairment or bad loan charges down 44% to £2.48 billion, and cutting costs, down 6% to £7.11 billion in the third quarter. One day, normal service will be resumed. And when it does, you will have to pay more to buy into this stock than you would today.

5) By embracing risk

Nothing is certain about Lloyds. Most surprises have been nasty ones, such as the recent PPI and dividend announcements. We don’t even know when the next tranche of shares will be sold to the public. Reports suggest it could be as early as next month. Or maybe April. Or possibly later this year. Who knows? We don’t know which scandal will strike the bank next. Or what fresh demands regulators will impose. But there are rewards for taking on this level of risk. Earnings per share (EPS) are forecast to grow a meaty 35% this year. That would take the price-to-earnings ratio to 11.6 times earnings. EPS are forecast to grow another 13% in 2015, knocking the p/e down to 10.3 times. These figures may be optimistic, who knows? But if you plan to hold the stock for five, 10, 15 years or longer, as you should, you should be immune to further short-term shocks.

Slowly.

In the longer run, it is the dividend income that will make you rich. If you reinvest them for growth, dividends will typically comprise up to 60% of your total return. The happy day when Lloyds starts offering a yield again has been put postponed again, which means no payout on 2013 earnings. Yes, that’s a setback, although if you’re investing for the long term, only a temporary one. If the Prudential Regulatory Authority plays nice, dividend payments could restart in the second half of this year. They will take time to grow, however. You may have to wait until 2018 before it pays out 50% of its earnings again. Lloyds could make you rich, but slowly. How patient are you?

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> Harvey doesn't hold any shares in Lloyds Banking Group.