The Lloyds (LSE: LLOY) share price has rallied strongly in recent days. It’s currently above the 60p mark, a level last seen in May. Even after the rise, could buyers of the shares today look forward to doubling their money?
Deal or no deal
The market’s been in a flighty mood this year. A sniff of an orderly Brexit, and the pound strengthens and investors rush headlong into UK domestic stocks. A hint of a no-deal withdrawal, and the pound weakens and there’s a stampede into stocks with high levels of overseas earnings.
Projections for the UK economy in the event of a disorderly Brexit are dire, which would be bad news for domestic banks like Lloyds. However, I’d also question the default optimism on the UK economic outlook in the event of an orderly Brexit.
Deal or no deal, the economy is cyclical. As such, I’m looking at Lloyds in terms of where we are in the cycle, and whether its valuation offers a big enough margin of safety to double my money before the next earnings-and-dividend-crushing financial crisis and/or recession.
Crises and recessions
According to the latest Fiscal Risks Report from the Office for Budget Responsibility (OBR), the UK has experienced seven recessions in the past 63 years, and four ‘major’ recessions in the last 50. The OBR also notes, “we might expect the UK to suffer a financial crisis around once in every 20 years.”
One lesson from history is that however hard regulators try to suppress risk in the financial sector, bankers are infinitely creative in finding new ways to expose themselves to it and the potentially higher rewards it offers.
Writing in 1990, Warren Buffett put this down to what he termed “the institutional imperative.” He explained this as, “the tendency of executives to mindlessly imitate the behaviour of their peers, no matter how foolish it may be to do so. In their lending, many bankers played follow-the-leader with lemming-like zeal; now they are experiencing a lemming-like fate.”
That was Buffett in 1990, but he could just as well have been writing about 2008–09 or any other financial crisis. It seems that bankers never learn.
The consequences for shareholders can be painful, because when assets are 15 or 20 times equity (as they are with banks), mistakes involving only a small portion of assets can destroy a large part of equity.
Double your money?
Maybe avoiding banks altogether wouldn’t be a bad strategy! However, I do think they present opportunities at times for value investors to buy low and sell high for a potential double-your-money return. Do I see Lloyds as one of these opportunities right now?
At a share price of 61p, it trades at a 15% premium to tangible net asset value (TNAV), at 8.3 times City analysts’ forecast earnings, and with a prospective dividend yield of 5.5%.
When I wrote in an article last month that I thought the time was finally ripe to start buying Barclays, the Barclays share price was at a 50% discount to TNAV, and at 6.5 times forecast earnings, with a prospective dividend yield of 6.5%. These metrics, particularly the eye-catching discount to TNAV, suggested a deep margin of safety.
Lloyds’ metrics, particularly the premium to TNAV, aren’t in the same value league. As such, I’m inclined to avoid Lloyds right now, as I see less downside protection and double-your-money potential.
We recommend you buy it!
You can now read our new stock presentation.
It contains details of a UK-listed company our Motley Fool UK analysts are extremely enthusiastic about.
They think it’s offering an incredible opportunity to grow your wealth over the long term – at its current price – regardless of what happens in the wider market.
That’s why they’re referring to it as the FTSE’s ‘double agent’.
Because they believe it’s working both with the market… And against it.
To find out why we think you should add it to your portfolio today…
G A Chester has no position in any of the shares mentioned. 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.