When you’re looking for your next investment, an accepted wisdom is to diversify to reduce risk. I’m a supporter of that idea generally, but it does raise a bit of a difficulty… what if you already hold, say, shares in 10 different companies and your 11th favourite is not one you’d otherwise buy?
My answer is simple: don’t buy it, but think about topping up on one of your favourites, instead.
That’s pretty much my feeling about Lloyds Banking Group (LSE: LLOY). It’s probably my favourite holding – I have no capital gain on it so far, but I’m earning some rather tasty dividends, and I still see it as undervalued.
I prefer safer blue-chip stocks these days, and though there are plenty of attractive constituents of the FTSE 100, every time I look at comparisons and run filters, Lloyds keeps popping up – and I keep thinking that I really want some more. But what do I like about it?
Hand me my cash
That brings me to my second reason – the dividend. In many ways a dividend is the only thing that matters with a company – even a growth stock that isn’t paying one today needs to eventually get to the point where it can start to pay out cash.
Lloyds’ dividend was suspended during the banking crisis, but it was restarted with a modest 1% yield in 2014 and climbed to 4.1% in 2016. With forecasts suggesting a step up in EPS in 2017, and dividend boosts, we could be seeing 5.8% this year and 6.4% next.
Why am I more confident in the dividend now than before the crisis?
Largely it’s because Lloyds has reshaped itself into a solid servant of the UK’s financial services market, and it’s improved its liquidity dramatically. I don’t kid myself that today’s minimum requirements will prevent any future banking crises – bankers will surely find new ways to bring doom on us while chasing short-term greed – but they’re onerous beyond what would have been imaginable back in 2007.
At the halfway stage this year, Lloyds was boasting a common equity tier 1 ratio of 14%. In addition, we heard of tangible net assets per share of 52.4p.
Oh so cheap
My third reason is simply that Lloyds is just too cheap. At 67p, the shares are trading at a premium to tangible net asset value of just 28%. That really doesn’t place a stretching valuation on the business itself.
On the P/E front, we’re looking at multiples of around only nine this year and next. That would be cheap for a company paying dividends at the long-term FTSE 100 average of around 3%. But for 6% dividends? Why are the shares so cheap?
Today’s low interest rates are part of it, for sure – the lower the base rate, the lower the spread from which banks can make money. But Lloyds looks cheap even with the base rate at 0.25%, and we’ve already heard from Bank of England Governor Mark Carney this week that rates could rise in the “relatively near term”.
And there’s Brexit, too, which seems dogged by fear, uncertainty and doubt. But that will be resolved, and I really don’t think it will turn out as bad for the banks as many fear. Even the pound is already regaining some of its lost ground as some Brexit progress is being made.
