The Motley Fool

Why I believe the Lloyds share price is too cheap to ignore today

While the FTSE 100 has gained 21% in the past two years, Lloyds Banking Group (LSE: LLOY) shares have managed a meagre 2%. And that’s over a period when the bank’s dividends have been storming back.

With earnings recovering strongly, the stock’s P/E multiple has slumped, and at under nine today it’s way below the FTSE 100’s long-term average of around 14. So is Lloyds actually on the road to long-term health or not?

Sign up for FREE issues of The Motley Fool Collective. Do you want straightforward views on what’s happening with the stock market, direct to your inbox? Help yourself with our FREE email newsletter designed to help you protect and grow your portfolio. Click here to get started now — it’s FREE!

Wednesday’s first-quarter update talked of “strong financial performance with significant increase in profit and returns on a statutory and underlying basis,”  to suggest it is.

Lloyds reported a pre-tax profit of £1.6bn for the three months to 31 March, which is a hike of 23% over the same period a year ago. On an underlying basis it was less impressive with a 6.4% rise to £2bn, and that’s possibly behind the market’s less than enthusiastic response to the news — as I write, the shares are down 1% to 65.5p.

The downside

One likely drag on the share price is Lloyds’ exposure to the PPI mis-selling scandal, the sheer scale of which is quite staggering. Its total PPI bill has reached as high as £18.8bn. To put that into perspective, it’s almost as much as the £20bn of taxpayers’ money that was pumped in to save the bank from the financial crisis.

On the upside though, the additional amount set aside this quarter was a relatively small £90m, and the deadline for PPI claims deadline of August 2019 will finally bring the sorry tale to its conclusion.

Bad loan impairments rose too, up to £258m, which is also a slight worry in these post-crisis days. And what other reasons might there be for shunning Lloyds shares? 

My Foolish colleague Kevin Godbold points to the cyclicality of the banking business. Lloyds has unarguably improved out of all recognition since the dark days of the bailout, and we have had a few years of rising earnings for banks in general as the world’s economies have been picking up.

But Lloyds is very much UK-focused, the British economy could well be heading for a sticky decade (despite the most recent figures not looking as bad as had been feared), and I reckon the first few post-Brexit years could be tough going. On those counts, the possibility that we’re heading for a down cycle in domestic banking has to be seen as realistic.

Low P/E ratios at other banks lend credence to such fears too — Barclays and Royal Bank of Scotland are on multiples of around 10.

Why I’m holding

But you know, these negatives are really all I could find in my search for reasons why I might be wrong to hold Lloyds shares. And even bearing them in mind, I’m convinced I have not made a mistake.

Fellow Fool Rupert Hargreaves has observed that Lloyds looks like it’s still being priced as a recovery prospect, when it is in fact far beyond that stage, and he points to its impressive return on equity performance.

My bottom line is that I just don’t see the 5%+ dividend being cut, especially as Lloyds is in the best liquidity position it’s enjoyed in years. I agree with Rupert that Lloyds shares deserve to be price ahead of, not behind, the banking sector average.

Want To Retire Early?

Do you want to retire early and give up the rat race to enjoy the rest of your life? Of course you do, and to help you accomplish this goal, the Motley Fool has put together this free report titled "The Foolish Guide To Financial Independence", which is packed full of wealth-creating tips as well as ideas for your money.

The report is entirely free and available for download today, so if you're interested in exiting the rat race and achieving financial independence, click here to download the report. What have you got to lose?

Alan Oscroft owns shares of Lloyds Banking Group. The Motley Fool UK has recommended Barclays and Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.