The first few months of 2016 have been a testing time to own shares in Lloyds (LSE: LLOY). The bank’s share price has bounced around, lacking any direction despite the fact that the underlying business continues to report improving profitability and management remains upbeat about the company’s outlook.
For example, Lloyds released its full-year 2015 results at the end of February. They saw the bank report underlying pre-tax profit of £8.1bn, up from £7.8bn in 2014 while underlying return on equity rose from 13.6% to 15%. Management also announced a special dividend of 0.5p per share, on top of the expected ordinary dividend of 2.25p. At a time when the majority of Lloyds’ peer group is cutting costs and reducing dividend payouts to save cash and improve their capital ratios, Lloyds’ decision to announce a special payout sends a message to investors. Management is extremely confident about the bank’s future.
And it’s easy to see why management feels confident enough about Lloyds’ outlook to declare a special payout. Lloyds’ Tier 1 capital ratio now stands at 13.9%, a level the majority of the bank’s European peers can’t match. Lloyds’ costs only accounted for 49.3% of the bank’s income during 2015 and as noted above, Lloyds return on equity last year was 15%. These are some of the most impressive metrics in the banking industry. Indeed, most large banks are currently only generating a return on equity of 10%, and many of Lloyds’ peers are struggling to get costs down to 50% of income or less. Lloyds is leading the global banking sector in terms of efficiency and profitability.
Not reflected
Unfortunately for investors, Lloyds’ sector-leading qualities aren’t reflected in the bank’s share price, and it’s easy to understand why.
The market is concerned about the effect lower for longer, or even negative interest rates will have on the banking sector (these concerns aren’t just limited to Lloyds). As a result, the consensus seems to be that the average investor should steer away from the sector.
However, with its sector-leading qualities, there’s no reason why investors should abandon Lloyds just yet. Even if interest rates remain where they are today for the next decade, Lloyds will continue to churn out around £8bn per annum in profit. Moreover, as the bank already has a fortress balance sheet with a Tier 1 capital ratio of 15%, the majority of the profits generated going forward will be returned to investors.
The long game
It’s almost impossible to say where Lloyds’ shares will be 12 months from now but according to City analysts, over the next 24 months, Lloyds could pay 10p per share to investors via dividends, excluding any special payouts.
So, even if shares in Lloyds go nowhere over the next two years, investors are still set to see a return of 15% in income alone over the next 24 months.
