Play The Percentages With Lloyds Banking Group PLC

How reliable are earnings forecasts for Lloyds Banking Group PLC (LON:LLOY) — and is the stock attractively priced right now?

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LLOYThe forward price-to-earnings (P/E) ratio — share price divided by the consensus of analysts’ forecasts for earnings per share (EPS) — is probably the single most popular valuation measure used by investors.

However, it can pay to look beyond the consensus to the spread between the most bullish and bearish EPS forecasts. The table below shows the effect of different spreads on a company with a consensus P/E of 14 (the long-term FTSE 100 average).

EPS spread Bull extreme
P/E
Consensus
P/E
Bear extreme
P/E
Narrow 10% (+ and – 5%) 13.3 14.0 14.7
Average 40% (+ and – 20%) 11.7 14.0 17.5
Wide 100% (+ and – 50%) 9.3 14.0 28.0

In the case of the narrow spread, you probably wouldn’t be too unhappy if the bear analyst’s EPS forecast panned out, and you found you’d bought on a P/E of 14.7, rather than the expected 14. But how about if the bear analyst was on the button in the case of the wide spread? Not so happy, I’d imagine!

Lloyds Banking Group

Today, I’m analysing Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US), the data for which is summarised in the table below.

Share price 75p Forecast EPS +/- consensus P/E
Consensus 6.9p n/a 10.9
Bull extreme 8.6p +25% 8.7
Bear extreme 4.9p -29% 15.3

With the most bullish EPS forecast 25% higher than the consensus, and the most bearish 29% lower, the spread, at 54%, is wider than the 40% range of the average FTSE 100 company.

Nevertheless, as Lloyds has been getting its house in order, earnings visibility has improved relative to a few years ago. Hence, the EPS spread has begun to come down, with analysts seeing a narrower range of plausible earnings scenarios ahead than previously.

As things stand, Lloyds’ 54% spread is much closer to that of the relatively-solid HSBC (46%) than recovery laggard Royal Bank of Scotland (118%).

Be that as it may, Lloyds’ spread does produce a pretty wide range of P/Es around a 10.9 consensus. The bear extreme of 15.3 crosses on to the expensive side of the FTSE 100 long-term average of 14. Meanwhile, the most bullish forecast puts Lloyds firmly in bargain single-digit territory.

With Lloyds earnings recovery only just getting underway, and the potential for growth to accelerate as we pull further away from the financial crisis, I don’t think it would be too worrying for long-term investors if buying today turned out to be at the bearish analyst’s 15.3 times forecast current-year earnings.

Another year down the line, and with the prospect of a dividend to boot, the market is likely to be a lot more comfortable in affording Lloyds a higher rating.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester does not own any shares mentioned in this article.

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