3 Reasons Why Investors Can’t Decide About Lloyds Banking Group PLC

Why can’t UK private investors make up their minds about Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US)?

Retail banking isn’t usually very exciting, but private investors trade Lloyds stock intensively, according to retail broker TD Direct Investing.

For example, last week, Lloyds was the most bought stock and the most sold stock among TD customers. The previous week, Lloyds was a top 3 buy and sell for TD.

Lloyds should be a boring high-yield income stock. The kind of share you buy and forget about.

Why isn’t it?

1. Too political

Ever since Lloyds’ £17bn bailout in 2008, the bank has been a politically-charged investment.

Investors haven’t known when the government would start to sell shares. We didn’t know when Lloyds would be allowed to restart dividend payments. As each of these events has unfolded, the bank’s shares have reacted sharply, usually going higher.

Since the general election at the start of May, Lloyds shares have gained another 5%.

News that the government plans to complete the re-privatization of the bank and is considering a discount retail offering of the shares within the next 12 months has been well received.

2. It’s cheap

Despite delivering a 40% capital gain over the last two years, Lloyds still looks cheap on most metrics.

The bank’s shares trade on a 2015 forecast P/E of 11.1 and offer a prospective yield of 3.1%, rising to 5.0% next year.

Coming from what should be a low-risk high street bank, this juicy income stream is the key to Lloyds’ attraction. It’s how the bank’s shares used to be seen before the financial crisis. Lloyds’ management is working hard to resurrect that reputation.

I believe Lloyds shares remain a good buy for income, even though dividend paid in April 2015 was the first since 2008!

3. It’s not cheap

Using one key measure of value, Lloyds’ shares are more expensive than any other major UK bank.

Lloyds currently trades on a price-to-book ratio of 1.25. All of the other big UK banks trade on a P/B of 1 or less. Only the small challenger banks trade at higher book valuations.

However, Lloyds still looks cheap on an earnings basis. Does this mean that it generates higher returns on its assets than Barclays, HSBC Holdings, Banco Santander and Royal Bank of Scotland, and deserves a higher P/B rating?

Lloyds certainly has lower costs than most of its peers and this is one of the reasons for its valuation.

In the bank’s latest results, Lloyds reported a cost: income ratio of just 47.7%. The equivalent figure at Barclays was 64%.

Lloyds lack of overseas and investment banking businesses means that it’s a relatively simple — and profitable — operation. However, I believe it’s also likely to limit Lloyds’ growth prospects, especially as the firm faces energetic competition from challenger banks such as Virgin Money.

Is Lloyds a buy?

At today’s price of 86p, I think the opportunities for capital gains on Lloyds’ shares are fairly limited. The income outlook is very attractive, however.

As a result, I’d buy Lloyds for income, but not for capital gains.

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Roland Head owns shares of Barclays and HSBC Holdings. The Motley Fool UK has recommended shares in HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.