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A Reason To Buy, And A Reason To Sell Lloyds Banking Group PLC

The incredible ascent of Lloyds (LSE: LLOY) (NYSE: LYG.US) shares in the last 12 months has fuelled investor and pundit speculation about the government selling its stake in the bank. But in this article, I want to talk about you — the private investor — and whether you should think about selling, or buying, a stake in Lloyds.

So, I’ll be taking two different points of view on Lloyds. One bullish reason why you might want to buy today. And one bearish argument for selling Lloyds shares, or avoiding them, if you don’t already hold.

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Let’s start positively, with a reason to buy Lloyds shares today. There’s little question in my mind that Lloyds’ feeble earnings of recent years do not fully reflect the bank’s true long-term earning power. Not only will Lloyds come out of its reorganisation a leaner, simpler, more stable bank — it will benefit from a more buoyant UK economy too, which seems to be continually improving.

For years after the financial crisis, the UK housing market had been severely depressed, and business confidence hit rock bottom. A few weeks ago however, the Bank of England confirmed that UK lenders had approved 61,000 mortgages in the last month, around 40% more than last year. Business activity surveys for UK manufacturing and services companies, meanwhile, recorded their biggest improvement since 1998.

As the biggest lender in the UK, Lloyds’ earnings could benefit from any further improvements in demand for mortgages and business loans. If that is true, it’s possible that Lloyds’ current valuation does not fully reflect these possibilities.

Sell the lot!

Now let’s take the bearish case. One argument against Lloyds is its track record. No, I’m not just talking about its lamentable performance in the last few years, or during the banking crisis. We know that Lloyds is in a different shape from a few years ago, and has ruthlessly tidied up its operations. But Lloyds was reputed as a sensible, utility-like bank once before, too. In fact, this was precisely Lloyds’ reputation before the financial crisis.

So did Lloyds create fabulous wealth for its shareholders when it was a steady, unremarkable lender, during a period without a banking crisis?

Let’s turn the clock back ten years or so. In 2002, the stock market was two years into a bear market, and an investor might have opted for those steady Lloyds shares as they sat at 700p. It turned out to be a great time to buy shares — over the next five years, an impressive bull market followed, on the back of a housing and banking boom that played directly to the hands of a large-scale lender. Surely Lloyds had a field day, from 2002 until before the crisis?

Through those boom years, between February 2002 and the peak of the bull market in 2007, Lloyds shares dropped 23% from 700p to 544p. Shareholders did however receive 364p in dividends, representing a total annualised return of around 6% over the period. This compares with a 10% annualised return for the total market over the same time period.

In other words, even during the banking and housing boom, a £10,000 investment in Lloyds became worth £7,700, with £5,200 paid to you in dividends. Meanwhile, that £10,000 would have become worth £15,373, if invested in the overall market. And those were the ‘good times’ … we all know what happened next.

So, in summary, my bear case is that even a fighting-fit Lloyds in boom-times might not be a business worth investing in. And after shareholders were diluted from 2m shares to 70m outstanding over the last 20 years, Lloyds’ shareholder woes have often been even more dramatic than the underperformance of its business.

Of course, whether you take either of these arguments as a reason to buy or sell Lloyds shares, is your decision.

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> Mark does not own any shares in this article.

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