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Why I’d buy Lloyds Banking Group plc before it is too late

If you have been hanging around, wondering whether to take a position in troubled banking giant Lloyds Banking Group (LSE: LLOY), you have been punished for your idle nature. The share price is on the march again, up 23% in the last six months. It has climbed from its year low of 47p to more than 67p. Can you afford to kick your heels any longer?

Rate of return

There is no question that Lloyds’ management still has to take arms against a sea of troubles. That is why I would urge investors to get on board while the valuation is still low, while many of these problems are priced-in. Currently, the bank trades at a tempting 7.8 times earnings, which really does look like a rather tempting entry point.

Perhaps that overstates the bargain you are getting. A price-to-book ratio of exactly one suggests this isn’t a dazzling bargain. However, I would expect a pricier valuation, given the storming dividend prospects at the bank. Even today, you get a yield of 3.4%. The forecast is to hit 5.3%. By the end of next year, that could top 6.1%. Given that the average access savings account currently pays just 0.37%, according to Moneyfacts.co.uk, these are storming rates of interest.

Going for growth

With consumer price inflation at 1.8% and forecast to hit 3% shortly, high income stocks like this one should look even more attractive, protecting the value of your money in real terms. With the bank committing to a dividend payout ratio of at least 50% of sustainable earnings, future progression should be strong. Investment bank HSBC recently calculated that underlying dividend growth should be “well in excess” of the 3p per share Lloyds is likely to pay out for 2016, thanks to high levels of revenues and profits in relation to risk-weighted assets.

Brexit has cast a shadow over Lloyds’ prospects, because even though the economy has held up surprisingly well the real work has yet to begin. This could knock wages, leading to a rise in loan defaults. It could also hit house prices and lending levels. Lower growth may also deter the Bank of England from hiking interest rates, making it harder for Lloyds to boost net lending margins. Earnings per share are forecast to fall 3% this year, and 6% in 2018. It is not out of the woods yet.

Way to go

So I am not starry eyed about this stock, which continues to face plenty of challenges, especially given the banking sector’s matchless ability to attract fines and penalties. However, JP Morgan recently praised Lloyds for its under-appreciated ability to generate capital and its best-in-class core Tier 1 capital generation. Slashing branch numbers by a third may generate negative headlines, but everybody knows branches don’t pay, so this should bolster profits. The bank will soon be completely in private ownership again.

Lloyds may be a little shop-soiled but that is reflected in today’s discounted price, and a rising dividend should offer some compensation while Lloyds smoothes out the wrinkles. Better buy today while it still looks cheap, than after the next upwards leg of the recovery.

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Harvey Jones 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.