As one of the UK’s largest retail banks, the fate of Lloyds (LSE: LLOY) is inextricably tied to the health of the domestic economy. As GDP growth in the first quarter slowed to 0.4%, it’s worth asking whether Lloyds shares are nearing their peak. Valuation wise, the market has priced shares well at around one times book value, which signals share price growth will have to come by growing the amount of assets on the books.
In this regard, Lloyds is almost entirely reliant on the economy growing due to its sheer size. It already originates 25% of first-time buyer mortgages and supports 20% of new small businesses. Realistically, growing market share enough to affect overall revenue is highly unlikely, so any growth will have to come from the economy kicking into high gear.
While it’s next to impossible to predict when the next recession will come, we do know it will happen eventually. However, it would be silly to sell a healthy company such as Lloyds while the economy is still growing, even if it’s by a low amount. But for investors on the outside looking in, remember the company’s growth will be slow and dividends will be the most likely source of returns in the years ahead.
Vulnerable to bad news
Online property portal Rightmove (LSE: RMV) unsurprisingly suffered greatly during the Financial Crisis as home sales dropped like a rock. The company has roared back in the years since and shares now trade at a princely 30 times forward earnings. The market has been enthusiastic on Rightmove because its nearly 80% market share for online home listings has allowed underlying operating margins to reach an astronomical 75.1%.
Rightmove is somewhat insulated from a downturn in the housing market since it makes its money by charging estate agents a monthly fee rather than taking a percentage of sales or charging by volume. However, any prolonged downturn in the housing market would likely create a repeat of June 2007- January 2009 when shares dropped over 70% in value during the worst of the Financial Crisis. For investors who’ve enjoyed the run up in Rightmove shares, selling now may not be the right call but at least be aware that such a lofty valuation means any sign of bad news could send shares plummeting.
London property developer Telford Homes (LSE: TEF) is at risk from any economic downturn for obvious reasons. The market is evidently worried about this vulnerability because shares are trading at a sedate 9 times forward earnings despite a 3.2% yielding dividend and three straight years of double-digit earnings growth.
While net debt of £50.4m and a subsequent gearing ratio of 37.3% is worrying, Telford has forward-booked 50% of revenue through 2019. This will help the company survive any short-term slowdown, but a longer downturn in the London property market would be devastating with some £1.5bn worth of developments in the pipeline. Few industries are as cyclical as housebuilding and owning a London developer amidst Brexit worries and slowing economic growth would be enough to cause me sleepless nights.
Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Rightmove. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.