What Return Can You Get From Undervalued Lloyds Banking Group PLC?

Investors are driven not by reason but by emotion, and are subject to fits of pique and cloudy judgement. Markets are irrational. People are irrational. The two go hand in hand.

The result is that perfectly sound businesses — even great businesses — trade for less than their true value. Let’s use a piece of consumer technology for illustration. If you take the world’s best mobile phone, and a store marks it down £50, is it anything other than a great product?

You’ve done your research and read all the five star reviews. It’s still that same phone, you’re just getting it for less.

Look at shares the same way. This is the principle that has made Warren Buffett the world’s richest investor. So, what might be a potential value buy today?

I’ve identified Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) as having plenty of upside.

But shares in Lloyds have exhibited weakness recently. We’re going to determine whether or not that’s reflective of the bank’s prospects, or if instead it’s an opportunity to pick up a solid blue-chip for a favourable price (then reap the gains!)

Is the market out of sync?

Since hitting a 52-week closing high in January (86p) Lloyds’ share price has fallen 12%. Less than a month ago the government sold a £4.2bn tranche of shares to institutions, and in the short amount of time since the shares have fallen 5%.

LloydsThere has to be a reason, right? Markets are efficient and therefore, given that brokers and analysts study big companies like Lloyds on a daily basis, the shares must be priced correctly?

Indeed, given the way most market professionals do their jobs, then it’s all the harder to step out of sync. They look at the same information as their peers, and often reach the same conclusions, or else their clients would query ‘why not?’ No one wants to look like a quack, after all.

As an individual investor, you have no such pressures. If you make mistakes then you’re only accountable to yourself. See what conclusions you can take from a further dissection of Lloyds.

Why Lloyds’ stock could soar

In the last 12 months Lloyds shares have performed well, and are up over 50% in the period. The shares have rallied on the prospect of a dividend. This would finally restore Lloyds to normal, after the lender last provided investors with an income in 2008.

The resumption of dividend payments, whether it happens this year or next, will undoubtedly make the shares more attractive, and it will be easier for the government to sell its remaining stake. Once those barriers are lifted, you ‘d expect the share price to jump.

If, as expected, Lloyds commits to paying out 50% of earnings to shareholders, then based on today’s share price Lloyds will provide an income of 5.3% in 2015.

Were Lloyds to become a steady income stock, could a price of £1 be out of the question?

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Mark does not own shares in Lloyds.