Rewind back to August 2011 and life as an investor in Lloyds (LSE: LLOY) was rather depressing. The bank was still loss-making, the government was a major shareholder and its share price was languishing at just 28p having fallen by an incredible 95% in the previous five years.
Since then, Lloyds has been one of the standout successes of the FTSE 100. While the wider index has risen by an impressive 26% in the last four years, Lloyds is up by 177%. Therefore, gains of another 67% over the medium term are starting to look a lot more achievable.
Of course, Lloyds was more heavily undervalued back in 2011. The market applied a discount to the bank’s net asset value since investors were unsure about the potential for future write downs of its asset base. However, these days Lloyds is very much a profitable business and, as such, no such discounts are necessary and Lloyds now trades at a premium to its net asset value, with it having a price to book (P/B) ratio of 1.15.
Furthermore, back in 2011 Lloyds was understandably paying no dividends, with it being more focused on raising capital through the sale of non-core assets rather than on making shareholder payouts. Today, though, it is a dividend paying stock and, as a sign of just how confident the bank’s management team is in its long term prospects, Lloyds is aiming to pay out up to two-thirds of profit as a dividend over the medium term. Clearly, it will take time to reach that goal but, in 2016, it is forecast to pay out almost 50% of earnings as a dividend, which should give investors in the company a degree of confidence regarding its future prospects.
Clearly, the UK economy is moving from strength to strength and, while a rising interest rate could put a dampener on consumer demand for credit and other loans, the rise in interest rates is likely to be more akin to turning a dimmer switch rather than flicking a light bulb on. As a result, Lloyds and its peers should benefit from a stable economic outlook, with there being plenty of scope to increase profitability and grow dividend payouts over the medium to long term.
Looking ahead to next year, Lloyds is expected to post earnings per share of 8p and, with its shares trading at 78p, this equates to a forward price to earnings (P/E) ratio of just 9.8. Were it to trade at 130p per share, it would mean Lloyds trading on a P/E ratio of 16.3 which, for a dominant bank in an economy that is performing exceptionally well, seems to be a rather appealing valuation.
Furthermore, if Lloyds was trading at 130p, its dividend yield would be 3% but, as mentioned, it is aiming to pay out two-thirds of profit as a dividend over the medium term. Because of this, it could easily be yielding over 4% and still have delivered capital gains of 67% in the meantime.
So, while gains of 177% in four years may not be repeated between now and 2019, Lloyds has the potential to reach and surpass 130p per share, which makes now a great time to buy a slice of it.
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Peter Stephens owns shares of Lloyds Banking Group. 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.