Is it time to give up on Lloyds Banking Group plc?

Lloyds Banking Group plc (LON: LLOY) could be heading for 25p or lower says Kevin Godbold.

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How long are you prepared to wait for shares in Lloyds Banking Group (LSE: LLOY) to come good? Private investors have been weighing up the firm’s juicy looking metrics for some time, but three years ago the shares were at 77p, higher than today’s 55p or so.

Peak earnings?

In July with its half-year results statement, chief executive, António Horta-Osório, said Lloyds has achieved robust underlying profit, a doubling of statutory profit and strong capital generation, along with continued progress on the company’s strategic initiatives.

That sounds impressive and, indeed, Lloyds expects to score a pre-tax profit of around £7bn this year, which is a long way from the £3.54bn loss the firm posted for 2011. However, during 2017, City analysts following the firm expect earnings to slip to £6.6bn. The racy earnings growth figures of recent years appear to be done. Lloyds has recovered from the chasm cleaved out by the financial crisis and any forward progress for earnings looks like being much harder to achieve — maybe we’re seeing peak earnings for Lloyds in this economic cycle.

Lloyds’ big problem

The bank looks attractive as an investment at first glance. Today’s share price around 55p throws up a forward price-to-earnings ratio of 8.4 for 2017 and the dividend yield runs at 6.7%. If Lloyds was a trading company with a steady record of earnings I’d be falling over myself to buy the shares. But Lloyds is a bank and as such perhaps the most cyclical of beasts you’re likely to come across on the stock market. To me, at this mature stage in the longer macro-cycle, as viewed back to the financial crisis, these metrics are unattractive and signal danger ahead for investors.

Any deterioration in the macro-economy, or expectation of such deterioration, will send bank shares plummeting, and rightly so. Profits can evaporate fast in a general turndown, so it makes sense that bank share prices should then be lower. We’ve see that effect recently with the Brexit vote. The problem now, after several years of rising profits at Lloyds, is that the market appears to be looking towards the next big downturn and marking down the firm’s valuation to compensate — as profits rise, the valuation gets meaner with a lowering P/E ratio and a higher dividend yield.

Volatility ahead

Lloyds’ cyclicality makes the firm vulnerable to any further macroeconomic deterioration, which  could send the shares plummeting, perhaps as low as 25p. Meanwhile, upside potential for the shares looks limited. António Horta-Osório reckons that the outlook for the UK economy following the EU referendum is uncertain but he thinks a deceleration of growth seems likely. That’s not a good forecast if you happen to be running a cyclical bank such as Lloyds.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Kevin Godbold has no position in any shares mentioned. 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.

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