Is Now The Time To Buy Lloyds Banking Group PLC?

After recent gains, is there still time to buy Lloyds Banking Group PLC (LON:LLOY)?

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Lloyds (LSE: LLOY) has staged an impressive recovery since the financial crisis. From the lows of 2011, the bank’s shares have gained 190%. Year to date Lloyds has outperformed the wider FTSE 100 by 9.3%. 

Since 2011 the bank has bolstered its balance sheet, reinstated a dividend payout, slashed costs, exited unprofitable markets and seen return on equity (ROE) increase almost three-fold. 

Many now consider Lloyds to be one of the best-run large banks in Europe and on one metric at least the bank looks cheap, Lloyds is currently trading at a forward P/E of 10.1 and analysts believe the bank will offer a yield of 4.9% during 2016. 

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So, in many respects Lloyds looks to be a great investment at first glance but is this really the case? 

Mixed emotions

When assessing Lloyds, many investors make the mistake that the bank should be compared to peers like BarclaysHSBC and RBS. However, Lloyds’ business model has changed drastically over the years, and it’s now difficult to compare the bank to any of its larger peers. 

For example, Lloyds no longer has a risky investment banking arm. The group is, for the most part, a retail bank and, as a result, income is more predictable. I’ve written about Lloyds’ new, simplified business model before; you can read about it here

Lloyds’ ROE is the best way of highlighting this fact. Specifically, Lloyds’ ROE hit 16% during the first quarter and management is targeting at long-term ROE of 13.5% to 15%. In comparison, many of Lloyds’ larger peers have long-term ROE targets in the low teens. 

Lloyds’ targets should be sustainable as, without a risky investment banking division, the bank’s income is more predictable. Investment banks are notoriously volatile operations.  

Low valuation 

After taking into account the fact that Lloyds has the ability to generate a stable, mid-teens ROE for the foreseeable future, it’s easy to conclude that that company should trade at a premium to its sector peers. 

And it does on an asset basis. Lloyds currently trades at a price to tangible book value of approximately 1.5. The European sector average is around 1.2 times tangible book.

However, on an earnings basis Lloyds trades at a discount to the wider European banking sector. As mentioned above Lloyds currently trades at a forward P/E of 10.1. The European banking sector average P/E sits in the mid-teens. 

Time to buy?

So overall, when you take into account Lloyds’ simplified business model, sector-leading ROE, a discount to its peers on an earnings basis and dividend growth potential, the company still looks undervalued.

That said, on an asset basis Lloyds does look expensive. But sometimes you have to pay extra for quality and this premium shouldn’t matter too much to long-term holders. 

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Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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