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Is Lloyds Banking Group PLC Due Colossal Gains?

The secret of successful investing: buy low and sell high. Unfortunately, most ordinary investors chase shares higher once the best gains have already happened. There’s less knack to buying high and selling low, and that’s why so many excel at it.

Banking stocks are popular among retail investors right now as there’s a view that they’re cheap. Bargains, even! Shares of Lloyds (LSE: LLOY) (NYSE: LYG.US), still 25% owned by the government, trade at 10 times next year’s forecast earnings. But the share price has more than doubled in the last two years. Will Lloyds become a triple bagger and rise by 200% any time soon?

It’s necessary for us to flesh out our definition of cheap here. Cheap, after all, can mean shoddy. A cheap share may be unable to consistently grow earnings; sales might be falling; or maybe the management is lacklustre.

So you should always consider a range of prospective investments, as by no means are all companies that trade on low P/E multiples alike. Some of these firms might be legitimately well-run but the market, for whatever reasons, is unduly pessimistic.

The banking sector bottomed out around the start of 2009 and some banks, such as Lloyds, only survived for the government taking control. While you may be wary of trying to catch a falling knife, I don’t envisage Lloyds taking a serious tumble now that legacy costs from scandals such as PPI appear over with.

So, about Lloyds triple bagging…

Out of rehab

The rehabilitation process at Lloyds is getting toward the latter stages now that the lender expects to apply to the regulator to restart dividend payments. It will do so in the second half of this year and analysts predict a 1.5p dividend next year (yield 1.9%).

Two years out a 3.6p dividend per share is forecast which would give a market-busting 4.7% yield. This wouldn’t stretch Lloyds, either, being covered 2.4 times by earnings per share.

If Lloyds truly is a value stock then we would expect to see the share price appreciate by a healthy sum. Analysts expect we’ll see earnings per share grow from 1.5p to 7.5p at the end of the current financial year and if we assume a P/E of 14 (which is around the FTSE average) then we could expect the share price to rise to 90p. Two years out a forecast 14% growth in earnings could see the share price hit 106p if we factor in the dividend.

Share performance

So by the beginning of 2016 we could see the shares lifted by 37%. That beats the FTSE’s performance in the previous two years by 12 percentage points, taking total gains to a mighty 225% since the beginning of 2012.

The question, for Loyds investors, centres on the remaining upside. Deciding when to sell a winner is always difficult and, for what it's worth, we believe only a handful of companies will make impressive gains in 2014.

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Mark does not own shares in Lloyds.