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Is Lloyds Banking Group PLC The Perfect Stock?

Since January 2012, shares in Lloyds Banking Group (LSE: LLOY) have risen by 238%. Shares in Royal Bank of Scotland Group have risen by just 78%, while Barclays shareholders have only seen a 60% gain.

At various points over the last year, I’ve suggested that Lloyds could be too expensive, or even a sell. Was I wrong?

Perhaps.

I think I may have underestimated the advantages of Lloyds’ simple, profitable business model.

Unlike Barclays and RBS, Lloyds is a simple retail bank without any overseas or investment banking operations.

As one of the UK’s largest mortgage lenders, Lloyds could have been heavily exposed to bad mortgage debts in the aftermath of the financial crisis. However, ultra-low interest rates and government support for house prices have prevented the kind of widespread mortgage losses we might otherwise have seen.

Top profits

A mixture of luck, political support and good management has resulted in Lloyds becoming one of the most profitable and well-capitalised banks in the UK, as these figures show:

 

Lloyds

Barclays

RBS

Adjusted return on equity

16.0%

7.6%

5.6%

CET1 ratio

13.4%

10.6%

11.5%

Cost: income ratio

47.7%

64%

64%

Net interest margin

2.65%

4.1% (excluding non-core)

2.26%

Lloyds scores highest on every count.

Although Barclays’ net interest margin of 4.1% appears higher, this is because the bank only seems to specify net interest margin excluding its troublesome non-core operations. Lloyds’ figure of 2.65% is for the entire bank.

One statistic that’s worth emphasising is Lloyds’ low cost:income ratio. This highlights the bank’s ability to generate cash to use for dividend payments, while maintaining a strong balance sheet.

Is there more to come?

After such a strong performance, is there more to come from Lloyds?

I believe there could, for two reasons.

Firstly, the government’s gradual sale of its stake in Lloyds is being well received by the market. The Treasury’s stake in Lloyds is now below 15%, following last week’s sale of another £558m of Lloyds’ stock. The bank’s return to private ownership is clearly generating strong institutional demand for Lloyds shares. These buyers are likely to be long-term holders.

Secondly, Lloyds seems to be delivering on its promise to become a reliable, high-yielding dividend stock, as it was before the financial crisis.

Analysts expect this year’s dividend payout to be 2.7p per share, or 34% of forecast earnings per share of 7.8p.

This payout ratio is expected to rise to 52% next year, when the dividend is expected to rise to 4.2p, giving a prospective yield of 4.8% at today’s share price.

Growth drivers

A steady recovery in the UK economy, coupled with a rise in real incomes and a stable housing market should help Lloyds to deliver steady profit growth over the next few years.

Interest rates look likely to rise, but only very gradually. In my view, the Bank of England is likely to do everything possible to ensure that rising interest rates, when they come, do not cause too much disruption to the housing market.

Overall, I believe Lloyds remains an attractive and relatively safe income buy that could also deliver modest capital gains.

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Roland Head owns shares in Barclays. 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.