Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) seems to be the flavour of the month at present. Its share price has risen by 52% since April, it recently posted a profit of £2.1bn for the first half of this year, and the government is expected to sell its 39% stake back to the private sector later this year.
Better still, Lloyds will soon begin discussions with its regulators about restarting dividend payments. So why do I think that now is a good time to sell Lloyds shares?
Why so expensive?
Lloyds’ share price has risen by 121% over the last year, giving the bank a trailing P/E of 39, and placing its shares on a forward earnings multiple of 15. On almost every measure, Lloyds now looks more expensive than its peers, but I can’t see any justification for this:
| Bank | 2013 forecast P/E |
2013 forecast yield |
Price to tangible book ratio |
|---|---|---|---|
| Royal Bank of Scotland | 16.8 | 0.0% | 0.76 |
| Lloyds | 15.0 | 0.2% | 1.37 |
| HSBC | 11.0 | 5.0% | 1.27 |
| Barclays | 8.7 | 2.5% | 0.85 |
Although RBS also trades on a high forecast P/E ratio, it does at least have the merit of trading substantially below its tangible book value, which adds a margin of safety to its valuation.
Trading on dividend hopes?
Lloyds’ chief executive, António Horta-Osório, has told investors he plans to pay out 60-70 per cent of earnings as dividends by 2015, assuming he gets permission from regulators to restart dividend payments.
By planning to pay out most of its earnings as dividends, rather than reinvest them in the business, Lloyds is admitting that growth opportunities in its core UK corporate and retail banking market are limited. However, that doesn’t mean it can’t be profitable, and I think this dividend policy explains the bank’s current valuation.
Analysts’ consensus forecasts currently suggest that Lloyds will earn of 6.3p per share in 2014. If 50% of those earnings were paid as a dividend, it would give the bank a 2014 prospective yield of 4.2% at its current share price. That’s high enough to appeal to institutional income investors, which is the kind of buyer Lloyds needs for the government to be able to shift its £20bn stake in the company back into private hands.
In my view, Lloyds’ current valuation has been inflated by the hope of generous dividends payments in a few years’ time. I don’t believe the bank deserves its current premium, and if I had invested in Lloyds as a recovery story over the last couple of years, I would be strongly tempted to sell up and lock in my gains.
An alternative to Lloyds
If you’ve already taken the plunge and sold your Lloyds shares, you may be looking for high-quality blue chip companies that currently look cheap.
Buying such companies has worked well for top UK fund manager Neil Woodford. If you’d invested £10,000 into Mr Woodford’s High Income fund in 1988, it would have been worth £193,000 at the end of 2012 — a 1,830% increase!
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> Roland owns shares in HSBC Holdings, but does not own shares in any of the other companies mentioned in this article.