Lloyds Banking Group (LSE: LLOY) is consistently one of the most traded stocks in the FTSE 100 index. But does that make the bank a good long-term purchase within an ISA? Today, I attempt to answer that question by looking at the bull case and the bear base for Lloyds.
Positive momentum
From an earnings point of view, Lloyds appears to have momentum. Recent results were solid, with profit before tax rising an impressive 158% on the year before, to £4.2bn.
CFO George Culmer stated that the bank was “strongly cash generative” during 2016, and that underlying profitability is likely to become “more stable and predictive going forward.”
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As well as improving its tier one capital base (CET1) by 80 basis points to 13.8%, another highlight of the results was the lack of exceptional charges, with misconduct charges more than halving to £2.1bn. PPI charges have plagued the bank in recent years, and placed a massive strain on profitability, however it now looks like the firm is finally starting to move forward.
Cash cow
The results brought good news for dividend investors with the company hiking its full-year payout by 13% to 2.55p, a yield of 3.8% at the current share price. Furthermore, the bank declared a special dividend of 0.5p, suggesting that management is confident about 2017.
City analysts forecast regular dividends of 3.7p and 4.2p for the next two financial years, yields of 5.5% and 6.3%, so Lloyds has the potential to be a cash cow if the company can deliver on expectations.
Cheap valuation
Lloyds also looks good value at present. With analysts pencilling-in earnings per share of 7.06p for 2017, it trades on a forward looking P/E ratio of just 9.4. By contrast, rivals Barclays and HSBC trade on forward looking P/E ratios of 11.2 and 13.6 respectively.
UK economy
However on the bear side, it’s worth remembering that Lloyds is highly exposed to the fortunes of the UK economy. Investors generally appear to be shrugging off Brexit for now, but if the UK was to suffer as a result of leaving Europe, it’s likely that profitability at Lloyds would decline. Unlike Barclays and HSBC, which have significant international operations, Lloyds generates 100% of its revenues within the UK.
Broker downgrade
It was for this exact reason that research house Berenberg cut its rating on Lloyds recently, advising investors to ‘sell’ the bank and placing a 55p target on the stock. The broker said it believes Lloyds is highly exposed to cyclical loan losses in the UK amid the twin risks of Brexit and rising interest rates, and that it forecasts earnings and dividends of around 15% below market consensus.
However weighing up the investment case as a whole, I’m cautiously optimistic about Lloyds. With Brexit about to kick off, there are definitely risks involved in holding the stock. But with a low valuation and a robust dividend yield, Lloyds has long-term appeal, and I may look to add the bank to my own ISA at some stage in the future.
