The Best Reason To Buy Lloyds Banking Group PLC

LloydsLloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) looks to be in the process of pulling off an impressive recovery — from a dead duck a few years ago that needed a taxpayer bailout to survive, to shaping up to restart dividend payments by the end of this year.

Since early 2012 we’ve seen the share price more than double, to today’s 766p. So is Lloyds a good company to invest in now? I think it is, and I think there are a number of convincing reasons — but what is it that sways me?

Return to profit

Is it the company’s return to profit on 2013, which saw a modest but positive statutory pre-tax profit of £415m reported? Admittedly that’s not a huge amount of money for one of our big banks, but chief executive António Horta-Osório did alert us to an “underlying profit more than doubled to £6.2 billion“, also telling us that “We have a strong business model and have made significant progress, despite our legacy issues, in improving our capital position and profitability in a sustainable way“.

Those are great figures, but it’s not what really moves me.

Is it profit forecasts, then? The City is predicting a pre-tax profit of £6.6bn for the year to December 2014, followed by £7.6bn a year later. Such profits would put the shares on a forward P/E of 10 this year, dropping to 9.5 next, and that’s way below the FTSE 100’s long-term average of about 14.

On its own, though, a low P/E isn’t enough for me — we’ve seen plenty of those in the banking sector in recent years and they did not always speak of bargains at the time!

Capital strength

How about Lloyds’ strongly improving capital ratios?

As of December 2013, Lloyds was looking at a pro-forma fully-loaded Common Equity Tier 1 ratio of 10.3% and Core Tier 1 ratio of 14.0%, which really is very good — easily satisfying the new requirements put in place by the Prudential Regulation Authority (PRA) in the aftermath of the banking collapse, and then some.

It was helped by Lloyds’ loan-to-deposit ratio dropping to 113% from 121% a year previously, and by its reduction in non-core assets. But it’s still not the real tell-tale that would convince me that Lloyds is worth buying.

Show us the cash

No, the icing on the cake for me is Lloyds’ plan to get back to paying dividends. The bank intends to ask for permission from the PRA to resume handing our cash in the second half of 2014, and with its capital ratios running way ahead of minimum requirements, it seems very unlikely that the PRA will refuse.

There’s not a great yield expected, just 1.7% this year — but analysts are expecting that to be boosted as far as 4.2% by 2015.

Future yields

But even that strong yield is not what really counts. If you buy Lloyds shares now, before its annual dividends get back to year-on-year growth, the effective yield you could be enjoying in five years’ time based on the price you pay today could be very attractive indeed.

And so it’s Lloyds’ confident approach to dividends that brings all the threads together for me, and says to me that Lloyds is well worth considering as an investment.

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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.