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Could the Lloyds share price crash 50% by the end of the year?

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As I write, shares in Lloyds Banking Group (LSE: LLOY) are trading at about 50p. That puts the stock on less than seven times broker forecast earnings for 2019, with a dividend yield of 6.8%.

Why are the shares so cheap? The only logical explanation is that investors expect the UK economy to crash and are pricing in a big drop in profits. I can certainly see some uncertainty on the horizon. But are the shares really likely to crash 50% before Christmas? I don’t think this is likely.

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Good value

In its half-year results, Lloyds reported a tangible net asset value per share of 53p. The bank said its return on tangible equity — a measure of profitability — was 11.5%. Over the full year, the bank expects this to improve to 12%.

By multiplying return on tangible equity with net asset value, we can get an idea of how much profit to expect. Based on the bank’s guidance, my sums suggest earnings of about 6.4p per share for 2019.

Given the uncertain outlook for growth, I think a safe valuation for the stock would be about eight times earnings. Using the figures above, this gives a share price of 51p. That’s pretty much where we are now.

The share price looks fair value to me at the moment, assuming profits are sustainable.

What if profits fall?

With the PPI deadline now past, the main risk I can see is that the value of Lloyds’ mortgages and loans will fall. The most likely reason for this would be an increase in bad debts. Recent economic data has highlighted slowing performance in the manufacturing and services sectors. If the UK goes into a recession and unemployment rises, then Lloyds’ UK-focused business could see rising losses from bad debts.

Indeed, we’ve already seen some signs of this. During the first half of 2019, bad debt charges rose by 27% to £579m. However, although this was a big increase, bad debts still only represent 0.26% of the bank’s £441bn loan book. That’s still quite low, by historic standards.

This is a risk worth watching. But based on what we know at the moment, I think the Lloyds share price already reflects a cautious outlook. Even if bad debt continues to rise during the second half of the year, I don’t think the increase will be big enough to justify a 50% share price crash.

Don’t panic!

In my view, if Lloyds’ share price does crash by the end of the year, the most likely reason will be a major market panic. I’d guess the most likely trigger for this would be a no-deal Brexit, perhaps combined with news that the UK is officially in recession.

I don’t know how likely this is, but the UK’s big banks are much stronger than they were in 2008/9. A major collapse therefore seems unlikely to me. If Lloyds shares crash to 25p later this year, then I would probably view it as a brilliant buying opportunity.

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Roland Head 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.

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