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3 reasons why I’d buy the Lloyds share price today

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In February, I explained why I believe Lloyds Banking Group (LSE: LLOY) remains a dividend buy.

Today I want to go into a little more detail about this and look at three areas which attract me to this stock as an income investment.

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1. The most profitable big bank?

One attraction of Lloyds is that it’s by far the most profitable of the big three UK high street banks.

The main measure used to judge profitability in banks is return on tangible equity, which compares after-tax profit with the bank’s net tangible asset value. Here’s how these big three compared in 2018:

Bank

Return on Tangible Equity (RoTE)

Lloyds

11.7%

Royal Bank of Scotland

4.8%

Barclays

3.6%

I admit that performance is improving at Barclays and RBS. I expect both banks to report rising returns over the next couple of years and rate them as value buys. However, turnarounds don’t always succeed. Investing in such situations carries some extra risk.

In contrast, Lloyds is already delivering the goods. The bank’s higher RoTE means that it’s now generating surplus capital. This is being used to fund shareholder returns.

2. Shareholder returns have doubled in four years

In 2015, Lloyds returned £2bn to shareholders through dividend payments. By 2018, this figure had doubled to about £4bn, made up of £2.3bn in dividends and £1.75bn of share buybacks.

What does this mean for shareholders? For the second year running, chief executive António Horta-Osório has opted to use some of the group’s surplus cash to reduce its share count.

For shareholders, the benefit should be that earnings per share rise more quickly, because profits are split among fewer shares. Last year’s £1bn buyback repurchased 1.6bn shares. I estimate that this year’s £1.75bn buyback could involve about 2.65bn shares.

Given that the bank has about 71.2bn shares at the time of writing, this year’s buyback alone should reduce the total share count by about 3.7%. However, I think the real reduction will probably be a little lower than this.

Bankers’ bonuses: Let’s use last year’s buyback as an example. Although the firm repurchased 1.6bn shares in 2018, its share count only fell by 0.8bn. One reason for this is probably that many of the shares repurchased were used to fund bankers’ bonuses.

Lloyds’ bonus pool for 2018 was £464.5m. Cash bonuses are capped at £2,000, with the remainder paid in shares. It seems fair to assume that the majority of the 2018 bonus pool will be paid in shares, purchased as part of this year’s buyback.

Indeed, my sums suggest that around one quarter of this year’s £1.75bn buyback may be used to fund last year’s bonuses.

In fairness, I think this kind of situation is fairly common at most major listed companies. I don’t see this as a reason to avoid the shares. If Lloyds couldn’t use repurchased shares for bonuses, it would have to issue new shares. This would dilute shareholders — arguably a worse outcome.

3. An income buy

Overall, I think Lloyds still looks decent value at current levels. Its balance sheet looks strong and the shares look affordable to me, trading at about 1.2 times their tangible book value and offering a forecast dividend yield of 5.3%.

In my opinion, this could be a good starting point for an income investment. I’d continue to buy Lloyds.

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Roland Head owns shares of Royal Bank of Scotland 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.

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