Investor confidence in Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) has been on the rise. The shares have soared more than 140% over the last couple of years.
Despite this mighty gain, Lloyds remains on a cheap earnings valuation at a share price of 77p. Based on City forecasts, the price-to-earnings ratio is 10.5 for this year, falling to 9.8 next year. Furthermore, history suggests that in recovery situations the analysts’ consensus is often behind the curve.
On an asset valuation, the bank doesn’t look cheap at 1.5 times tangible book value. But book value did tick up — rather than falling — for the first time in many moons in Lloyds’ latest quarter.
The big seller
The UK government began to sell the taxpayer’s 39% bailout stake in Lloyds last September.
The first sale reduced the holding to just under 33%. While Lloyds’ shares immediately dipped 5%, they quickly recovered to their previous level; and have held up well since, compared with a decline of 10% for the banking sector as a whole. The government’s second sale in March, which reduced the holding to under 25%, produced a similar dip, but again it was a short-term effect.
Anticipation
The market is anticipating the government to complete the disposal of its holding in Lloyds before next year’s General Election, and for Lloyds to resume paying dividends on the same timescale.
There are potential hiccups, which could be holding exuberance back a bit for the moment. For instance, further charges for mis-selling payment protection insurance beyond the £10bn the bank has provisioned for (£2.3bn remains unused) could delay the re-starting of the dividend.
However, if management’s bullishness is justified and the UK’s economic recovery continues apace, I reckon that as anticipation moves towards confident expectation, and expectation to realisation, we’ll see demand for Lloyds’ shares rising, underpinned by the return of income-seeking investors.
Income
Analysts are expecting only a symbolic first dividend of 1.5p, giving a yield of 1.9%; but see this rising to 3.3p for a 4.3% yield next year. Forecasts suggest the dividend would represent only 40% of earnings, but analysts reckon the payout ratio could reach as high as 70% in time.
With Lloyds due to approach the regulator in the coming months about restarting dividends, and a further reduction of the government’s shareholding also on the cards, it may not be long before the market starts to celebrate the prospect of a fully rehabilitated Lloyds by pushing the shares up once again.