Is Lloyds Banking Group PLC The Best Bank For 2016 And Beyond?

The investing public still seems to have a love-hate relationship with our FTSE 100 banks, and that’s not really surprising as some of them are still facing serious risks – HSBC Holdings and Standard Chartered in particular could have some serious debt problems in China should the property bubble burst there.

But that fear is extending to our better recovery prospects, like Lloyds Banking Group (LSE: LLOY), whose shares have lost 20% since their recent peak in May, to hit 73p.

It comes after the bailed-out bank had comfortably passed a series of Bank of England stress tests. As a result of the most recent one, announced in early December, chief executive, António Horta-Osório was moved to say: “These strong results […] demonstrate the progress we have made in de-risking our balance sheet as well as the group’s strong capital position and capital-generative business model“.

Dividends are key

The price fall also comes after Lloyds was permitted by the PRA to start paying dividends again in the second half of 2014, two years ahead of fellow struggler Royal Bank of Scotland‘s forecast dividend return. Last year’s cash payment did only yield 1%, but there’s a much more attractive 3.3% expected this year, followed by 5.1% next, and those payments would be comfortably covered by earnings.

The prospect of a small fall in earnings in 2016 might be holding some investors back, but there were no signs of trouble in Lloyds’ third-quarter update in October. Income for the nine months to 30 September was flat at £13.205bn, with the bank reporting an underlying profit of £6.355bn for a 6% rise on the same period a year earlier.

Crucially, impairment charges were down 64% to £336m, showing that the days of toxic debt are increasingly fading into the past. There was a provision of £500m for PPI issues in the third quarter, but it’s likely that the days of PPI claims are going to be brought to a close before too much longer.

How cheap?

This all paints a pretty attractive picture to me, but what really provides the icing on the cake is Lloyds’ current valuation. Based on earnings forecasts for 2015, the shares are on a P/E of a mere 8.5. That would rise a little to 9.2 if 2016’s modest fall in EPS comes off, but it would still be way below the FTSE 100’s long-term average of about 14.

And of course, that 2016 P/E is for a share that’s expected to deliver a dividend yield of 5.1%, which is way ahead of the FTSE’s relatively meagre 3% or so. To reach just the FTSE average P/E, Lloyds shares would need to gain more than 50% to around 110p, and I really don’t think that’s an unreasonable prospect by the end of 2016.

The City says Buy!

And to top it all off, there’s a pretty overwhelming Strong Buy consensus among the analysts out there. They are, admittedly, often wrong, but this time I think they have it spot-on. Obviously you need to do your own analysis and make up your own mind, but Lloyds looks so cheap to me that I haven’t been able to resist buying some.

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Alan Oscroft owns shares in Lloyds Banking Group. The Motley Fool UK has recommended 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.