Was The City Dead Wrong About Lloyds Banking Group PLC?

LloydsThis time last year, Lloyds (LSE: LLOY) (NYSE: LYG.US) was flying high after an incredible 90% surge in its stock price between September 2012 and 2013. (Anyone remember when bank shares used to be “boring”?!)

At the time, pondering Lloyds’ new-found popularity, I asked what the City experts thought Lloyds was likely to earn in the years ahead.

Why? Well, when we’re hunting for bargain stocks here at the Motley Fool, we need to come to an estimate of what an underlying business could be worth — and the valuation of all shares depends on how much cash that company is capable of generating over time.

Analysts had just upgraded Lloyds’ earnings estimates by a further 8% to a consensus of 5.41p per share for 2013, and 6.54p per share for 2014. This placed the shares on a forward price-to-earnings multiple of 13.3, and may have tempted many an investor to get on board with the burgeoning recovery story. So, was the City’s new optimism right on the money, or did the experts get it wrong?

As it happens, the consensus estimates may have drastically underestimated Lloyds’ near-term recovery prospects. And after making even further strides to turn itself around, it now seems Lloyds is expected to make more than £7bn in pre-tax profit this year — or 7.2p per share.

Great news, right? It could be — but for Lloyds shareholders who have owned the stock over the intervening 12 months, it may not seem that way, with the shares almost exactly flat over the past year.

So, what gives — things appear to have gotten even better for Lloyds’ earning prospects, but the shares are still languishing, now on a forward P/E of just 9.3. Should we be racing out and buy the shares?

I actually agree that Lloyds looks cheap today, given the progress in its turnaround story, and what the company should be capable of earning based on its considerable asset base. And as a long-term business minded investor, I’m not one to be put off by the prospect of share price volatility from the Scottish referendum.

But I think there’s a useful lesson to be learned here in how rapidly analysts can revise their estimates of a company’s earning power — and how the market’s reaction to this can often confound ordinary investors. There are a great many factors which drive share prices, and analysts are often quick to change their mind about a stock. By focusing on these short-term factors, investors can make costly decisions.

We're long-term investors here at the Motley Fool, and in our flagship Share Advisor service, we focus on investing in businesses for years rather than months. It's over that kind of time horizon that we can make sensible judgments on how a business is likely to perform, and whether the price is right.

If you'd like to see what I'm talking about, this investment dossier from our top Fools may be of interest to you.

It's called 'The Fool's Five Shares To Retire On', and it's currently free to download. It contains the five shares which we believe could be perfect for building a long-term portfolio. If you're looking for investment ideas, which you can act on right away, this would be an ideal place to start.

Mark Rogers has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.