Last year, my wife bought shares in Lloyds Banking Group (LSE: LLOY) at a price of 43.5p per share. As I write, the share price stands at 48.2p, up 10.8% on our buy price. But I’m keen to buy more Lloyds shares soon. Here’s why.
The shares look cheap to me
At its 52-week low on 13 October last year, the Lloyds share price bottomed out at an intra-day low of 38.5p. At this price, the Black Horse bank’s shares looked like a screaming bargain to me.
But even after leaping 25.2% since then, they still look undervalued to me. Here’s why I’d gladly buy more Lloyds stock today.
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1. The stock is lowly rated
At the current price, the shares trade on a price-to-earnings ratio of 6.7. This translates into an earnings yield of 14.9%, versus around 8% for the wider FTSE 100 index.
In other words, buying Lloyds stock today would generate almost 1.9 times more earnings than buying the entire FTSE 100. To me, this suggests there may be value hiding in this bank stock.
2. The shares offer a 5% cash yield
Currently, the FTSE 100 stock offers a dividend yield of 5% a year. That’s around 1.35 times the FTSE 100’s cash yield of 3.7% a year. As a veteran value and income investor, this looks like a decent reward to me for holding Lloyds shares for the long term.
3. Dividends are covered three times by earnings
Of course, future dividends are never guaranteed, so they can be cut or cancelled at any time. Indeed, during 2020-21’s ‘pandemic panic’, Lloyds temporarily suspended its cash payout.
However, I’m optimistic that the bank’s directors might lift 2023’s dividend to exceed last year’s payout of 2.4p a share. That’s because this payout is covered almost three times by historic earnings.
Also, even if the bank has a tougher 2023 than 2022 — which I fully expect — I expect no cuts to the dividend.
4. Lloyds has a strong balance sheet
The Common Equity Tier 1 (CET1) ratio is one important measure of a bank’s financial strength. At the end of 2022, Lloyds’ CET1 ratio was 14.1%, comfortably above its target of 12.5%.
Retained earnings boost this ratio, while paying out dividends and other disbursements reduces it. I consider this level of high-quality regulatory capital to be perfectly adequate for the bank’s ongoing solvency.
5. Lloyds is buying back £2bn of its shares
Finally, the bank unveiled a new £2bn share-buyback programme with its 2022 full-year results. If fully implemented, this would reduce the size of the share base by around 6.3%.
Reducing the share base boosts future earnings per share, because these are spread across fewer shares. Over time, it should also lift dividends per share.
Finally, though I’m bullish — that is, positive — on Lloyds shares right now, I could be wrong. Slowing economic growth or a full-blown recession could hit bank earnings. Also, rising interest rates and falling disposable incomes could well lead to higher bad debts and loan losses.
Even so, I’d eagerly buy more Lloyds stock today — if I had enough spare cash, that is.
