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Why Lloyds Banking Group plc would be the first stock I’d put in my ISA

It’s ISA season again and you have just three weeks to use this year’s £15,240 tax-free allowance, or lose it for good. Some of the urgency may have gone with the allowance hitting a massive £20,000 from 6 April, but that’s no excuse to hang round. The sooner you invest, the longer compound interest has to work its magic.

Home grown

My top stock for this year is Lloyds Banking Group (LSE: LLOY), but you will need to give it a little time. Recent performance has been bumpy, with the stock 16% lower than three years ago, but it has picked up momentum in recent months.

Anyone considering Lloyds must first take a view on the UK economy, because this is primarily a domestic banking play. The UK economy has held up well since Brexit, with the Office for Budget Responsibility upgrading its 2017 GDP forecasts from 1.4% to 2%, but the phoney war will be over within days, as Prime Minister Theresa May’s finger hovers over the button marked ‘Article 50’.

Narrow margin

There are signs of economic weakness, with UK industrial output shrinking in January and consumer sentiment still fragile. UK high streets endured their worst February since 2009, as consumers are squeezed by growing inflation. If private and business customers are on the rack, Lloyds will feel their pain.

The slower the economy grows, the lower the chance of meaningful base rate hikes. Lloyds need higher rates to maintain and increase its net lending margins, but despite Fed action and recent noises from MPC hawks such as Kristin Forbes, it will have to be patient.

Cost control

The case for Lloyds right now depends on Brexit. There will undoubtedly be wobbles ahead, which could open up even more tempting buying opportunities. But today’s forecast valuation of just 9.6 times earnings still looks like a good entry point. Operating costs fell 3% last year to £8.1bn, giving Lloyds a sector-best cost-to-income ratio of 48.7%.  Forecast earnings per share growth of 141% this year also point to the bank’s potential.

Lloyds is making money, with 2016 underlying profits beating forecasts to hit £7.9bn, down slightly from £8.1bn in 2015. The full-year dividend payment rose 13% to 2.55p, and investors also pocketed an additional special dividend of 0.5p. With the yield forecast to hit 6.3% in 2018, up from 3.7% today, this is a must for income seekers. 

Smoother road

Lloyds is the UK’s biggest mortgage lender and although the property market is slowing slightly – thankfully – there seems little prospect of a crash, given the current housing shortage. So its lending book should have plenty of protection on that front.

There is finally an end to the PPI disaster in sight, which has hit Lloyds harder than anyone else, with the bank setting aside an astonishing £16 billion so far. The Financial Conduct Authority has a two-year cut-off on claims and although this could trigger a final flurry of claims, the scandal will soon be consigned to history. 

Lloyds is also shrugging off the humiliation of state ownership, with the Government stake down to just 3.89% of its total share capital, and can start looking forward to a brighter future. Inside your ISA, maybe?

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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.