Ben Graham, the father of value investing, once said: “In the short run, the market is a voting machine but in the long run, it is a weighing machine”.
What this means is that sentiment can move a company’s share price in the short term but sooner or later the market will price the business based on its fundamental value. If we invest when sentiment has pushed the shares down below fundamental value, we’ll do well in the long run.
Today, I’m looking at where Lloyds (LSE: LLOY) currently stands in terms of sentiment and fundamental value. Will investors do well in the long run?
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Voting
Over the last two years, shares of Lloyds have traded as high as 89p and as low as 48p and are changing hands at 63p today.
The low of 48p came in the wake of last summer’s EU referendum. Ahead of the poll, there were warnings from the government, Bank of England and most FTSE 100 companies that a ‘no’ vote would have all manner of adverse consequences for the country, including lower economic growth and possibly a recession.
However, the economy is performing much better than the worst-case predictions. The Footsie has recovered from the post-referendum sell-off and Lloyds’ shares have climbed from their low of 48p. Was this a case of the market voting in the short run? Or is the fundamental value of the bank really less than 50p?
Weighing
Lloyds’ tangible net asset value (TNAV) currently stands at 54.8p, so if the shares were to trade at 48p today, they’d be on a P/TNAV of 0.88. Put another way, you’d be able to buy £1 of Lloyds’ assets for 88p.
As well as looking fundamentally undervalued on assets, the bank would also look incredibly cheap based on its current-year forecast earnings and dividend. The forward price-to-earnings (P/E) ratio would be a bargain-basement 6.9 and the prospective dividend yield would be a whopping 7.5%.
Of course, you can’t buy Lloyds’ shares for 48p today. But are they still fundamentally undervalued at 63p?
Looking to the future
At today’s price, Lloyds’ P/TNAV is 1.15, the forward P/E is 9.1 and the prospective dividend yield is 5.7%.
Lloyds is nearing the end of its long recovery from the financial crisis and the government’s remaining bailout stake in the bank is down to below 2%. The Black Horse has a strong balance sheet and has passed stress tests for a range of adverse economic events with flying colours. It has a market-leading cost-to-income ratio, which means it’s a highly efficient bank.
By 2019, it expects to be making a return on equity of between 13.5% and 15%. I see this as a sustainable long-term rate of return and regard a P/TNAV of 1.5 as a fair valuation. That would imply a share price of 95p, giving a P/E of 13.7 and a dividend yield 3.8%. As such, I think the shares are very buyable at 63p.
Of course, the price could be volatile as Brexit negotiations unfold and the UK economy could also go through a period of depressed activity, if business investment and consumer spending become overly cautious. However, I would view any negative ‘voting’ by the market in the short term simply as a good opportunity to buy more shares for the long run.
