It’s been a slightly disappointing year so far for shareholders of Lloyds Banking Group (LSE: LLOY). The bank’s stock is down by 3% so far in 2018. And the Black Horse is also underperforming the FTSE 100, as my Foolish colleague Edward Sheldon recently noted.
Personally, I see this as a short-term blip. In this piece I’ll explain why I think there’s a good chance that the bank could end up beating the Footsie this year.
Three good reasons
I’ve often found that if an investment is too hard to understand, it’s unwise to buy.
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One of the things I like about Lloyds’ business model is that it’s simple. It’s a retail bank that provides bank accounts, loans, mortgages and credit cards to individuals and businesses in the UK.
I think the bank’s financial attractions can be summed up with three sets of figures.
1. Good value
At the end of March the bank reported a tangible net asset value of 52.3p per share. The last-seen share price of 65p gives it a price/tangible book ratio of 1.2. That’s not expensive for a profitable, dividend-paying bank.
The shares look cheap compared to earnings, too. Analysts’ consensus forecasts are for earnings of 7.5p per share this year, putting the stock on a forecast price/earnings ratio of just 8.8.
2. Increasingly profitable
One of the main measures of profitability for banks is return on tangible equity. This compares after-tax income with the bank’s tangible net asset value.
Lloyds reported a return on tangible equity of 8.9% in 2017. During the first quarter of 2018, this figure rose to 12.3%. That’s a fairly decent figure and compares well with rivals such as RBS (9.3%) and Barclays (11%).
The bank’s profitability is improving thanks to underlying growth. But costs are also falling. Underlying costs accounted for 46.8% of the bank’s income last year, compared to 58.2% at RBS and 73% at Barclays.
3. A strong dividend
One of Lloyds’ main attractions is its dividend yield, which is expected to hit 5.2% this year. The forecast payout of 3.44p per share is expected to be covered 2.2 times by earnings, providing solid cover.
Ultimately, the affordability of a bank’s dividend is linked to the amount of surplus capital it has. This is measured by the Common Equity Tier One (CET1) ratio, a key regulatory measure.
The Black Horse bank reported a CET1 ratio of 14.1% at the end of March, after allowing for dividends. That’s comfortably ahead of the bank’s 13% target, and suggests to me that this year’s payout should be very safe.
What about the economy and Brexit?
My colleague Royston Wild recently highlighted some of the economic risks that could affect Lloyds’ future profits.
Although I share some of these concerns, my feeling is there’s not yet any concrete evidence of a slowdown. Bad debt levels remain fairly low and in April, government figures showed wages rising ahead of inflation for the first time in a year.
Lloyds has performed well in recent years and chief executive António Horta-Osório has delivered on his promises. At the bank’s current share price, I believe this stock could be a good buy for dividend investors.
