After coronavirus hit the markets, Lloyds Banking Group (LSE: LLOY) bottomed out below 25p in September 2020.
Today’s price of around 47p shows just how far the stock has travelled with its rebound since then. But it’s been higher. At the end of May, it was just above 50p. And in 2019, before the pandemic, the shares spent a fair amount of time above 60p.
It’s clear what drove the move up this year. Earnings plunged by almost 70% in 2020. But city analysts have pencilled in a rebound of more than 380% in 2021. And I think earnings tend to drive share prices more than any other factor. Sometimes those earnings are actual and sometimes anticipated.
Before Covid-19 arrived, Lloyds stock had been travelling essentially sideways for around six years. There had been ups and downs along the way, but the trading range was clear. And the price never seemed to be able to break through a cap of around 90p.
However, during that period, the business was improving and earnings were generally rising year after year. There’s only one explanation for the price action. Instead of the stock moving higher to accommodate rising earnings, the valuation contracted instead. And that’s why Lloyds ended up looking so cheap.
Indeed, prior to the pandemic, Lloyds had a low price-to-earnings ratio, the price to asset value was below one and the dividend yield was high. Clever stock market, I say. And when I say stock market, I mean the many individual investors who make up the market for stocks.
The challenges of cyclicality
Why so clever? Because the market ‘knew’ the next move for Lloyds’ earnings and the stock price would likely be down. Nobody knew about Covid-19, of course, but many people knew that cyclical stocks have accentuated downside risks after the underlying business has enjoyed a long period of high earnings.
For that reason, Lloyds will never make a decent long-term hold for me. However, the stock can be lucrative as a vehicle for capturing a shorter-term move up.
For example, the share shot higher between March and September 2009 after the financial crisis and credit crunch. And I think we’ve been seeing a similar fast recovery following the pandemic.
But, for me, the danger now is that we could see a further prolonged period of sideways stock action followed by another plunge in earnings in the end.
Analysts have recently revised their expectations lower and pencilled in a slight decline in earnings for 2022. Meanwhile, if the business meets estimates for 2021, profits are already in the ballpark of pre-pandemic levels.
So I’m cautious about Lloyds now, despite the low valuation and the high dividend yield. Of course, I could be wrong. Earnings could take off in the years ahead. And at the end of the last century, the valuation was much higher.
That situation could happen again, driving the stock price way beyond the previous six-year range. But I’m seeing limited potential now, so I’d look for stock opportunities elsewhere.
The post Should I buy Lloyds Banking Group stock? appeared first on The Motley Fool UK.
Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2021