MENU

Is Lloyds Banking Group PLC The World’s Best Bank?

Lloyds (LSE: LLOY) (NYSE: LYG.US) has made a strong recovery since the financial crisis. Progress over the last six months, and expected progress this year, should see the bank pretty much back to full health.

Yet despite the positive developments, anyone who invested at just about any time during the past 18 months has yet to see a return on their investment. Bullish commentators have been saying for ages that Lloyds is cheap, yet the shares haven’t risen in a year-and-a-half — while we’ve seen stunning gains from some companies in other sectors of the market. It’s a bit of a conundrum.

Progress

Lloyds has made great progress over the last six months in a number of areas. These include the disposal of TSB (mandated to be done by the end of 2015 as part of the government bailout conditions), passing the 2014 banks stress test conducted by the Prudential Regulation Authority (PRA), and getting permission from the PRA to resume paying dividends to shareholders — a good indication that the regulator now believes Lloyds has a robust and sustainable business.

Furthermore, Lloyds’ annual results in February showed that on a number of key metrics the bank was stronger than its FTSE 100 rivals — and the same goes for future targets. For example:

  • Lloyds’ cost:income ratio of 51% knocked spots off that of other banks, and the Black Horse expects the ratio to continue galloping down — to 45% by the end of 2017.
  • Lloyds reported a strong common equity tier 1 ratio of 12.8%, compared with — for example — RBS‘s 11.2%.
  • Lloyds posted a rising return on equity (ROE) with a 2017 target of 13.5%-15%, while HSBC — for example — posted a drop in ROE and revised down its target to “more than 10%” from a previous 12%-15%.

Bargain

Despite Lloyds’ relative strength on a number of important metrics, the bank is trading on a bargain-basement forecast price-to-earnings (P/E) ratio of less than 10, which is significantly lower than Barclays (11.1), HSBC (11.5) and RBS (12.4).

On dividend yield, too, Lloyds has great value credentials. Analyst forecasts give a yield of 3.5% this year, rising to 5.3% next year — with the dividends well-covered by earnings. Those yields are way ahead of RBS’s expected lowly dividends, comfortably higher than Barclays’ forecast yields (3.2% rising to 4.3%), and not far below — on next year’s payout — HSBC’s 5.8% (which is not as well-covered by earnings as Lloyds’ dividend).

Not surprisingly, many investors are looking at Lloyds’ current share price of 78p and thinking: if Lloyds were valued on its 2016 dividend at a market average yield, it shares would be trading at 120p, and, if Lloyds were valued at a market average P/E, its shares would be trading at 130p.

What’s holding Lloyds’ shares back?

The ongoing sale of the government’s stake in Lloyds, which is now down to 21%, is seen by many as an anchor, which, once released, will send Lloyds’ shares soaring like a hot air balloon.

However, I think there’s also another factor that’s been holding Lloyds’ shares back. While the P/E and yield would be perfectly reasonable if the shares traded at 130p, Lloyds would rate, on another key valuation measure (price-to-tangible net asset value — P/TNAV), as one of the best banks of its kind — perhaps the best — in the Western world!

Now, while I think Lloyds is worthy of having its praises sung, the UK banking environment — which includes punitive political profit grabs and the promotion of challenger banks — is likely to make it tougher for our banks to match the level of returns possible for banks in some more favourable markets overseas. In short, as things stand, I don’t think Lloyds can possibly rate as the best bank in the world.

Looking towards 130p

The good news is that Lloyds doesn’t actually have to be the world’s best bank in order to deliver super returns for shareholders. For example, a P/TNAV of 2 would be below the world’s best, and, I think perfectly reasonable. So, to see that mooted 130p share price, we’d need a TNAV per share of 65p. At 31 December the TNAV was 54.9p, a rise of 6% from 30 September — a rate which, if it continued, would see a TNAV of 65p reached as soon as this September. For various reasons that may be optimistic, but I’ll be keeping a close eye out for the latest TNAV when Lloyds releases Q1 results on Friday.

It’s impossible to say whether the smartest move would be to invest in Lloyds today, or after the results, or in the proposed retail offer later in the year, if the current government wins the Election. One thing’s sure, though, investors buying at the moment will not have to wait as long for a possible tasty rise in the shares as those who bought in during the last 18 months of stagnation.

Banks are certainly difficult to weigh up, and have delivered more than their fair share of nasty surprises in recent years -- and there may still be unseen bumps in the road to come. If you're looking for an investment with a clearer route to outstanding growth and returns, you may wish to read this FREE Motley Fool report.

You see, the company in question is a leader in its sector, and is on the brink of a bold global e-commerce expansion that could TREBLE profits within 5 years.

This company's potential has been spotted by the Motley Fool's market-beating experts, but has not yet been recognised by most investors. More details of this emerging opportunity can be found in the FREE report -- "3 Hidden Factors Behind This Daring E-commerce Play".

To find out more with no obligation, simply click here now.

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