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As the FTSE 100 hits 7,000, I’d buy its only penny stock

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The stock markets have enthralled many investors lately, with the benchmark FTSE 100 index breaking through the 7,000 barrier. Shares might be moving up in price overall, but I still believe there are good value shares to buy now for my own portfolio. I wouldn’t expect to find many penny stocks in the top flight index – but even now there is still one.

Here I look at the only penny stock currently in the FTSE 100 index. I also explain why I’d buy it now for my own portfolio.

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Well-known penny stock

It might seem surprising that a 7,000-level FTSE 100 would contain any penny stocks at all.

I regard a penny stock as one that trades for less than a pound. Until recently there were several in the index. But as the market broadly has moved higher, the penny stocks in the FTSE 100 have been reduced to a single name.

That name may be surprising. It’s Lloyds Bank (LSE: LLOY).

Blue chip penny stocks

Penny stocks are sometimes highly speculative ventures whose business prospects are hard to gauge.

I don’t think that describes Lloyds, though. The banking powerhouse operates under a stable of brands including Halifax and Bank of Scotland as well as its eponymous Lloyds. That gives it economies of scale but also the ability to reach different customer segments.

Shares touched £3 before the financial crisis. But that existential experience pushed the company into penny stock status. Its shares have remained there ever since. 

Future earning potential

When evaluating Lloyds, I see these penny stocks as undervalued.

Last year Lloyds dealt with the costs of the pandemic and its sudden economic impact. But it still recorded 1.2p of earnings per share. The prior year it earned over twice as much. As the economy recovers from the pandemic, I am hopeful that it can restore earnings to pre-pandemic levels. With a price-to-earnings ratio of 12, using the pre-pandemic earnings level, I see significant future earning potential I don’t think is reflected in the shares’ status as penny stocks.

Positive momentum

A lot of share pickers seem to have revised their view of Lloyds. Its shares are already up 25% in 2021 – and 48% over the past year.

But I believe a number of drivers for further momentum exist.

Improved business performance could be one. Another is a continued low rate of defaults in the UK mortgage market. Lloyds is the biggest lender in that market. I was thus pleased to note that while Lloyds substantially increased its provisions for bad loans last year, it noted in its annual report that “observed credit quality remains stable”.

I also think further positive dividend news could help the shares. The company restored its dividend and signalled its planned return to a progressive dividend policy. Its common equity tier 1 ratio jumped from 13.8% to 16.2%, partly due to not paying dividends last year. That is above its target, which suggests it could use excess funds for future dividends.

Risks remain

Despite my bullishness, only Lloyds remains in the ranks of penny stocks in the FTSE 100. Clearly there are some risks.

The bank’s heavy exposure to UK mortgages could be problematic if there is a housing crash. The pace and scale of the economic recovery could also affect financial performance.

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christopherruane owns shares of Lloyds Banking Group. 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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