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Surprise! Lloyds Banking Group PLC is 5% ahead of the FTSE 100 in 2017

2017 has been a good year for investors in Lloyds (LSE: LLOY). The bank’s shares are 5% ahead of the wider index and this has pushed their gain to 18% in the last three months. That’s despite a somewhat uncertain outlook for the UK and global economy. Looking ahead, there could be more outperformance ahead, but does this mean that now is the right time to buy a slice of the bank?

A changing business

The last few years have seen a huge change in fortune for Lloyds. It was once considered a hugely risky place to invest, with the potential for asset write downs, large losses and an unstable strategy. Today, however, it is in a much stronger position in all of those areas. Its balance sheet is now much stronger than it was a few years ago thanks to asset disposals as well as a focus on growing the parts of the business which offer the greatest reward for a given level of risk. And with the bank being in the black, and now highly efficient as a result of major cost cutting, its long-term growth potential is high.

Dangers ahead

However, Lloyds is a relatively cyclical stock and so it could be hurt by the impact of Brexit on the UK economy. So far, Brexit has made little or no difference to UK GDP growth. However, the outlook is less positive, since higher rates of inflation could mean that consumers feel the squeeze. In turn, demand for new loans may fall and borrowers could find it more challenging to service existing loans, since their wages may be rising by less than inflation.

In such a scenario, Lloyds could suffer more than most of its banking peers because it has a relatively large exposure to the UK economy after its acquisition of HBOS. While this means it has benefitted from a strong UK economic performance in recent years, there is a risk that this will reverse over the course of 2017.

Value appeal

Lloyds currently trades on a price-to-book (P/B) ratio of just under 1. This indicates that it offers a wide margin of safety, so that if the economy struggles and the bank is forced to write down the value of assets, its shares may not fall by a large amount. Such a low P/B valuation suggests upside potential.

It’s a similar story with the bank’s income prospects. They indicate that Lloyds could see its share price rise significantly and remain relatively enticing to new investors. For example, it yields 5.6% from a dividend which is covered 1.9 times by profit. This suggests that its dividends are sustainably high, and it could even become one of the most attractive income plays on the FTSE 100. Therefore, now seems to be the right time to buy Lloyds ahead of potential further outperformance of the wider index.

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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.