Despite a late surge in November, Lloyds Banking Group (LSE: LLOY) ended last year down by more than 40%. So why would I buy Lloyds shares in 2021? Put simply, I think the bad news is priced-in.
In my view, the Lloyds share price is likely to rise ahead of the market over the next few years. Let me explain why.
1. Dividend nightmare will soon be over
A significant part of last year’s share price plunge was caused by the suspension of Lloyds’ dividend in April last year. This wasn’t the bank’s choice — the UK banking regulator forced all the big banks to cancel their dividends in order to preserve capital. No payouts were allowed in 2020.
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The fear was that banks would need their spare cash to fund losses on bad loans. I’ll come back to this subject in a moment, but for now what matters is that in December, the regulator said that banks could restart dividend payments in 2021.
The regulator’s view is that Lloyds and other banks are strong enough to handle the impact of the Covid-19 pandemic. I agree. Although there will be some restrictions on payouts at first, I expect Lloyds’ dividends to return to an attractive level quite soon.
Broker forecasts suggest a forecast yield of 4.3% for 2021, rising to 6.5% in 2022. I think payouts at these levels would be likely to provide a boost to Lloyds’ share price.
2. Losses are priced-in to Lloyds’ share price
The big banks failed miserably in the last major recession and Lloyds ended up needing a government bailout. But things are quite different today.
Lloyds went into this crisis with a much stronger balance sheet and plenty of surplus capital. Although the bank expects to record bad debt charges of £4.5bn-£5.5bn for 2020, these losses look manageable to me when compared to shareholders’ equity of £43bn.
As I write, a 37p share price means that Lloyds stock trades at a 30% discount to its tangible equity value of 52.2p per share. However, the bank returned to profit in the third quarter with a £1bn profit. If this performance continues in 2021, I’d expect this discount to close.
3. New boss
I think that CEO António Horta-Osório has done a good job at Lloyds. But after a tough 10 years, he’s moving on. Mr Horta-Osório’s replacement is Charlie Dunn, whose current role is global head of Wealth and Personal Banking at HSBC.
I expect that Mr Dunn will be keen to promote growth in more profitable areas, such as wealth management. He may also adjust the group’s UK strategy to support long-term growth. This could drive a significant revaluation of the business.
Why I’d buy Lloyds shares
Let me sum up. Over the next year or so, I think we’ll see Lloyds’ dividend return to something like its pre-crisis level. If I buy the shares at their current level, I’d expect a 4%+ yield this year.
Looking further ahead, I expect the bank’s new management to focus on improving profitability. Even a small improvement could drive Lloyds’ share price much higher, in my view.
More profitable specialist banks already trade at a premium to their book value — for Lloyds, this could see the shares double from current levels.
There are no guarantees, of course. But I’d buy Lloyds today without too much worry.
