It has been a mediocre year so far for shareholders in Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US). The share price is down nearly 4%, lagging the wider FTSE 100 (FTSEINDICES: ^FSTE) by more than 5%.
Of course, those of us who owned Lloyds shares in 2013 mustn’t be greedy. Last year we saw our bank rise more than 60% in value in just 12 months – an incredible move for a massive company with a market cap of well over £50 billion.
Last year’s soaring share price reflected relief that the worst was behind the bank, and that profits and dividends would soon be on the way.
But I think the recovery in Lloyds’ share price may be only just beginning.
Tangible upside
The measure that makes me think there could be plenty more to come in Lloyds is its price-to-tangible book value per share multiple.
That’s quite a mouthful. What does it mean?
The tangible book value of a company is the value of its ‘hard’ assets. These are the assets it lists on its balance sheet minus intangible assets such as brands, goodwill from acquisitions and so forth.
Theoretically, if a company was to cease trading and to go into liquidation, shareholders would at a minimum be left with its tangible assets. The ‘tangible assets per share’ is how much of this value each share would theoretically be entitled to in such a scenario. (Real life is not so neat, but it’s a useful working assumption).
The price to tangible book value (PTBV) is simply the share price of the company, divided by the tangible assets per share.
Triples all around?
You might think that a share price should never fall below a company’s tangible assets per share. If it did, then theoretically shareholders could vote to wind up the company and at least get their money back.
In practice banks saw their PTBV multiples plummet during the aftermath of the financial crisis, as investors were fearful of overpaying for companies whose futures looked in doubt, as well as distrusting the value put on their tangible assets.
Lloyds’ PTBV fell below 0.5 at times! Investors only had to spend 50p for every £1 of hard assets they acquired.
So much for the bad times — when fear rules the markets, bargains often abound.
But what might the PTBV ratio be in the good times?
Currently Lloyds is trading at a PTBV of 1.3, which seems pretty heady after the lows of the past few years
However as the graph below shows, its PTBV got above 4 in the years before the crisis:
If we were to see Lloyds achieve that again, then even with no change in its asset base the share price would hit £2.24, which would triple your money from today.
Even a less heady PTBV multiple of 3 would see the share price double.
The ‘but’ bit
Of course, there are those who think that the banks will never achieve the PTBV multiples they enjoyed before the financial crisis.
Some argue this is because banks will never again be so profitable because they’ll never be allowed to stretch their lending as far as they did before the slump. Others say investors will simply never again trust banks enough to pay high multiples.
Either case would see investors unwilling to bid up the share prices of banks, and so elevate their PTBVs.
Of these two arguments, I think the first is the most credible. Banks are more highly regulated, and they need to hold much more capital. However, I believe this is far more of an issue for investment banks than it is for ‘safer’ mortgage banks like Lloyds.
Moreover, I think the demise of ruthless rivals such as Northern Rock who tried to grab market share by striking essentially unprofitable deals means Lloyds will over time write more profitable business than it did before the slump. That could offset some of the capital headwinds.
Never say never
As for the trust argument, frankly I think it’s specious.
Investors have short memories. If the banks deliver profits and dividends and there are no more blow-ups for a few years, then they’ll be trusted again. Indeed the tighter regulation may work in the banks’ favour, as investors may bet that regulators have made banks safer by outlawing riskier practices.
