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I would be happy for him Lloyds Banking Group (LSE:LLOY) share price to get back to what I paid when I first bought some.
I mean, it’s been a poor performer for years. And the recovery from the 2022 crisis has stalled.
But that must surely give people who buy today a better chance of getting their money fivefold, right?
What needs to change?
For some stocks, it can be difficult to arrive at any kind of valuation. This is especially true for growth stocks, particularly if they haven’t achieved earnings yet.
Analysts use various measures related to sales, asset values, and all sorts of things. But until we see sustained gains, all of this may veer off course.
But we don’t have that problem with Lloyds. Banks make profits and we have measures related to profits.
And that brings me to the first thing I should change. I’m talking about valuation. And valuing bank stocks is not easy now.
Rating, rating
Forecasts put Lloyds shares at a price-to-earnings (P/E) ratio of 5.8. I think it’s too low, considering the long term. FTSE 100 average up to around 15.
But the big question is: what is a fair P/E valuation for a bank? In the past, banks have scored highly. But the financial crisis shattered any illusion of infallibility. It turned out that banks were not the safest things on the planet.
On the contrary, new regulations mean that banks’ balance sheets must now remain much stronger. But the investing world has not yet adjusted to where bank valuations should be.
Major minor?
Maybe a little below average Footsie? Maybe around 12? That kind of revaluation could double Lloyds’ share price.
Then we get to the dividend yield, and we’re looking at a 6% forecast from Lloyds. That’s above the index average of 3.9%. Lloyds’ share price would therefore need to rise by around 50% to bring its return down to the average.
Combined, the P/E and dividend yield suggest a revaluation could boost Lloyds shares by between 50% and 100%.
I’d be happy with that. But to get to five times earnings, we’re going to need significant earnings growth.
Profits
We don’t really have much growth in play right now. So I’ll have to resort to speculation.
Let’s assume that Lloyds can grow its earnings by 5% per year and that the P/E remains at the current low level of 5.8. My spreadsheet suggests that at that rate it would take about 33 years for Lloyds’ share price to increase five-fold.
However, that is without any change in valuation.
If we expect the P/E to increase by 50% to 100%, that would suggest 19 to 25 years to get five bags.
This would add to the annual flow of dividends that investors would also enjoy.
What does it mean?
Now, I’m not trying to predict anything here. I’m just trying to show what it might take for Lloyds’ share price to quintuple.
And, despite the clear risks right now, this makes bank stocks look cheap to me.
