Rewind the clocks a year and the mood among investors in Lloyds (LSE: LLOY) (NYSE: LYG.US) was very different than it is today. Indeed, shares in the part-nationalised bank had risen by 54% since the turn of the year at that point and investors in the bank were highly optimistic that the next year would mean more growth for their bottom line.
However, Lloyds has disappointed over the last year, with its share price being up just 3% since 21 November 2013. Worse still is the performance of shares in Barclays (LSE: BARC) (NYSE: BCS.US) since that date, with them being down 6% over the last year.
Looking ahead, though, could Lloyds rekindle its 2013 performance next year and make gains of more than 50%? If so, can Barclays mirror its sector peer and turn around 2014’s dismal share price performance?
Margin Of Safety
Lloyds and Barclays both have wide margins of safety included in their current share prices. In other words, the market is anticipating further negative news flow for both stocks and is expecting further challenges for them both as we emerge from the global financial crisis. For example, Barclays has a price to book (P/B) ratio of just 0.7, while Lloyds’ P/B ratio is also relatively low at 1.4. Furthermore, the two banks have price to earnings (P/E) ratios that are also depressed, with Barclays having a P/E ratio of 11.4 and Lloyds having a P/E ratio of 10.1.
Clearly, there is scope for an upward adjustment to both ratios for both banks, especially while the FTSE 100 has a P/E ratio of 15.4, for instance. That’s 35% higher than Barclays’ rating and 52% higher than Lloyds’ P/E ratio, which indicates that there is considerable share price growth potential in both stocks moving forward. And, in the case of Lloyds, it’s enough to reach our target of a 50% rise in its share price in 2015. Indeed, it would only take a P/E ratio equal to the wider index to achieve this level of return.
Growth Potential
With both banks being focused on the UK, their bottom lines are expected to improve rapidly in the current year as the UK economy picks up pace and cements its position as the fastest growing developed economy in the world. In the case of Lloyds this means that the bank is forecast to return to profitability for the first time since the credit crunch, with earnings set to grow by a further 6% next year. In the case of Barclays (which has been profitable throughout the credit crunch), it means that earnings are set to grow by 23% in the current year, and by a further 28% next year.
This means that Lloyds could be trading 61% higher in a year’s time (broken down as a 52% gain from an upward rerating so that it equals the FTSE 100’s P/E ratio, multiplied by 6% from earnings growth). Meanwhile, Barclays could see its share price trading 73% higher from a combination of a higher rating (+35%) and strong bottom line growth (+28%) multiplied together.
Looking Ahead
Certainly, there are difficulties on the horizon. For example, PPI claims are not yet closed, while fines for alleged wrongdoings cannot be ruled out for the banking sector. In addition, a weak Eurozone could hold back UK economic performance in 2015, with investor sentiment also having the potential to weaken due to Russian sanctions, unrest in the Middle East, and the threat of an Ebola outbreak.
However, Barclays and Lloyds can make gains of at least 50% in 2015. Lloyds achieved that feat in 2013 and, with both banks trading on very low valuations and having extremely positive earnings forecasts for the next couple of years, it is a realistic target for both banks to make share price gains of 50% in 2015.
Of course, they’re not the only banks that could post exceptional gains next year. In fact, I think that all investors could benefit from an attractively priced banking sector that has significant future potential.
