Investors in Lloyds (LSE: LLOY) are currently unlikely to think that they’ve bought shares in the best investment in the world. That’s because the part-nationalised bank’s share price has fallen by 11% since the turn of the year and it feels as though the government is no closer to selling off the remainder of its stake.
Despite this, Lloyds has tremendous potential to deliver a superb return in the long run. A key reason for this is the state of the bank, with it being highly efficient compared to a number of its rivals, as well as having a sound balance sheet that has been aided by numerous asset disposals. Both of these positives should help Lloyds to deliver rising profitability in the long run, with the bank being in good shape even if there’s an economic downturn.
Government exit
Further evidence of the strength of Lloyds is the fact that the government is now ready to end its part-ownership. It was meant to do so earlier this year but this was postponed due to above average market volatility. However, the fact that this move is imminent shows that Lloyds has made excellent progress with its turnaround strategy in recent years and is now ready to stand on its own. Once the government share sale is done, investor sentiment towards Lloyds could improve as the market gradually moves on from focusing on its challenging performance during the credit crunch.
In terms of Lloyds’ financial performance, it seems to be moving in the right direction. It’s now highly profitable following the losses of recent years and with its bottom line due to grow next year, investor sentiment could pick up over the medium term. And if investor sentiment does improve, there’s plenty of scope for an upward rerating since Lloyds trades on a heavily discounted valuation.
For example, Lloyds has a price-to-earnings (P/E) ratio of only 8.6 and when the bank’s efficiency, growth potential and financial strength are taken into account, this indicates that its shares could rapidly rise. In fact, even if Lloyds were to double in valuation it would mean that the bank’s shares would have a P/E ratio of 17.2 which, while not exactly cheap wouldn’t be grossly high either.
Of course, with such a low valuation comes a higher yield. Lloyds currently pays out a rather modest 57% of profit and yet yields 6.8%. This is higher than the vast majority of the bank’s index peers and while there’s the prospect of reduced dividends if the economic outlook for the UK and the rest of the world deteriorates, even a halving of dividends would still leave Lloyds yielding a very impressive 3.4%. And with dividends forecast to rise by 16% in 2017, Lloyds’ income appeal is likely to soar.
So, while 2016 has been a disappointing year, Lloyds has income, growth and value appeal, which together make it one of the best investment opportunities around.