Before the financial crisis began, and the bank’s subsequent government bailout, shares in Lloyds Banking Group (LSE: LLOY) changed hands for as much as 590p each. However after being bailed out by the taxpayer, shares in Lloyds crashed to a low of around 20p at the end of 2011 as the bank’s problems looked unsolvable.
Nearly six years on and Lloyds is completely unrecognisable. Profits are booming and the bank is back on the hunt for acquisitions. In fact, its recovery has been so impressive it is now widely considered to be one of the best capitalised and most efficient banks in the euro area. As a result, it now looks as if it’s setting a course back to 600p.
Look to the long term
Suggesting that shares in Lloyds might return to the pre-crisis high of 590p might seem a tad too optimistic, but such a target is not wholly unreasonable.
Lloyds’ government bailout involved the issue of tens of millions of new shares, diluting existing shareholders but saving the bank. While the cash call has helped ensure Lloyds’ future, a larger number of shares in issue means Lloyds is going to have to work extra hard for the price to return to 590p. For example, in 2007 the bank reported pre-tax profits of £4bn, earnings per share of 58.3p. In comparison, for full-year 2016 it reported a pre-tax profit of £4.2bn and earnings per share of 2.9p.
Still, even though a higher share count will slow the return to 590p, I don’t believe this target is impossible in the long term.
Some back-of-the-envelope maths shows why. If we assume that Lloyds can grow basic earnings per share by 3% per annum for the next two decades, the bank is on track to report earnings per share of 12.6p by 2037. This is a very conservative estimate and only assumes steady growth in line with economic growth/inflation. Placing a multiple of 12 times earnings on per-share earnings of 12.6p gives a share price of 152p.
Lloyds currently supports a dividend yield of 5.4%, significantly above the market average, which currently stands at around 3.5%. Assuming this level of payouts continues, the total return on offer from Lloyds’ shares will be much higher than the real earnings growth figure.
Factoring-in dividends, as well as the possible impact from share repurchase activity, gives a much greater long term total return number.
City analysts believe Lloyds’ management is likely to turn to share repurchases as the bank tries to return excess capital to investors. Using very rough estimates to calculate the potential total return available from both share repurchases and dividends on the shares, indicates that the stock could rise by over 600% during the next two decades. Assuming a sustainable dividend yield of 5% and 5% per annum earnings per share growth (boosted by share repurchases) gives a total return of 10% per annum. On this basis shares in the bank could hit 470p within two decades, or 505p if dividends are reinvested. If organic earnings growth hits 5% per annum, with a 2% buyback kicker and 5% dividend yield, the shares could return 12% per annum hitting 646p in two decades.
In other words, assuming Lloyds doesn’t have to ask for another taxpayer bailout, shares in the bank could return to their pre-crisis high within 20 years.
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Rupert Hargreaves 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.