Lloyds Banking Group (LSE: LLOY) shares are on my buy list. Here are three reasons why I’d add this FTSE 100 bank to my portfolio today.
Rising interest rates
The big banks have worked hard to shed the bad habits that got them into trouble in 2008. They’ve made good progress, but one key ingredient has been missing from their recovery — higher interest rates.
Near-zero interest rates have made it hard for banks to offer competitive mortgage rates without cutting their profit margins. But that’s all starting to change.
With UK inflation at 10%, rates are rising. The Bank of England base rate has already risen from 0.25% to 1.75% so far this year. Most experts expect another increase in September.
The rising bank rate is allowing Lloyds to increase the interest rates it charges on mortgages and loans. That’s helping Lloyds to generate bigger profits from lending.
Improved profitability should lead to stronger cash generation, supporting dividend growth.
A 13% shareholder return?
One simple valuation method used by City number crunchers is to use the expected dividend growth rate to forecast share price gains. The idea behind this is that if a dividend yield stays the same, then the shares will rise by the same amount as the dividend each year.
Obviously, things don’t always work out this way. But I find this can be a useful way to spot shares that might be undervalued.
Looking at Lloyds, the stock’s forecast dividend yield for 2022 is 5.4%. In 2023, the dividend is expected to rise by 8%. Adding these two numbers together gives me an expected total return (dividend yield plus share price gain) of just over 13%.
That’s well ahead of the long-term average total return from UK stocks of around 7% per year. This is one reason why I think Lloyds shares could be cheap at current levels.
Buying Lloyds shares at a discount?
The other reason why I think Lloyds looks cheap is that the bank’s shares are still trading below their tangible book value of 56p.
A discount to book value is a traditional value indicator. In recent years, this discount might have been explained by poor profitability. But with interest rates rising, I don’t think this applies anymore.
In my view, Lloyds shares are likely to trade much closer to their book value in the future. They could even trade above book value, if the bank’s profitability stabilises at a higher level.
The perfect time to buy?
I always ask myself what could go wrong before I buy a share. With Lloyds, the risks are obvious enough.
There’s a fair chance that the UK could fall into a recession, before the end of this year. This could lead to a sharp rise in bank losses from bad debt and a slowdown in new mortgage lending.
In July, Lloyds said that it hadn’t yet seen any signs of trouble. But with winter coming and a potential energy crisis, problems could lie ahead.
I’m not blind to the risks. But I think Lloyds’ shares are already priced to reflect possible problems. In my view, the shares offer good value on a long-term view. I’d be happy to buy at current levels.