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Why I reckon the Lloyds share price could smash the FTSE 100 next year

I have been positive on Lloyds Banking Group (LSE: LLOY) for quite some time now. For example, in November last year I noted that it was trading at a forecast valuation of just 8.6 times earnings and suggested it might be worth a closer look.

I wrote at the time: “It may still lack a clean bill of health but the rising dividend will reward you while you wait for the medicine to work.” One year later, it remains on the sick list.

Lloyds lost

The Lloyds share price is down 15% over the past 12 months, falling at twice the speed of the rest of the FTSE 100, which is down 7%. Measured over five years, Lloyds is off 30% but the index is up 4%. It is therefore a serial under-performer.

However, it looks even more of a bargain than it did a year ago, now trading at just 7.3 times forecast earnings. That is roughly half the valuation across the FTSE 100 of 15.56 times, so Lloyds looks the bigger bargain. It also offers a juicier forecast yield of 5.6%, with generous cover of 2.3, beating the 4.01% yield across the index.

Better still, the Lloyds’s yield is forecast to total 5.8% this and 6.3% next year. So why aren’t investors buying in droves?

Too focused

The wider stock market sell-off hasn’t helped. Nor has Brexit and the uncertain UK economy, given that Lloyds has a laser-like 97% focus on the domestic market. Today it trades at just 57p and Alan Oscroft is beginning to wonder whether it will ever beat 100p again. Like me, he is frustrated by its continuing low valuation.

Yesterday’s third-quarter report didn’t help, as an increased restructuring charge and yet more conduct penalties sent statutory profit before tax falling 7% to £1.8bn. Yet Q3 underlying profit was broadly unchanged at £2.1bn, and Lloyds remains on track to meet its targets.

Deadlines, deadlines

If Prime Minister Theresa May somehow strikes a deal with the EU and we all enjoy a post-Brexit bounce, Lloyds could be one of the bigger beneficiaries. Interest rate rises may follow, which should give it the opportunity to boost its net lending margins, although this could be offset by a rise in bad debts and loan impairments.

Lloyds is therefore at a Brexit crossroads (like the rest of us). It is a similar story as the PPI mis-selling scandal draws to a close, with a final claims deadline of 29 August 2019. This may trigger a costly last-minute claims rush but at least it will put a firm floor under the whole sorry episode.

Deja vu

With City analysts forecasting a dip in revenues next year, you might prefer to hunt down other bargains on the FTSE 100 instead. However, Lloyds still looks highly tempting to me. This year it has returned more than £3.2bn to shareholders, including its £1bn share buy-back (and there’s speculation of a £2bn buy-back next year). 

The bank may still lack a clean bill of health but the rising dividend will reward you while you wait for the medicine to work. Now where have I read that before?

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harveyj has no position in any of the shares mentioned. The Motley Fool UK has recommended 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.