As I write, with the share price close to 45p (and falling) the Lloyds Banking Group (LSE: LLOY) share price has plunged almost 30% since the beginning of the year.
Because of that move, the historical dividend yield has shot above 7%. And City analysts have previously pencilled in mid-single-digit percentage increases for the shareholder payment for this year and in 2021.
The problematic argument for cheapness
Lloyds is a well-known name with a big market capitalisation – it appears high up in the rankings of the FTSE 100, no less. Surely, it’s time to shrug off all the fear surrounding the COVID-19 coronavirus outbreak and buy some shares in Lloyds to tap that generous income stream from the dividend, right?
After all, the company has been displaying tempting-looking value indicators for years. Now, for example, the forward-looking earnings multiple for 2021 is around 6.5 and the price-to-book rating is about 0.7. Then there’s that generous dividend, which should be covered almost twice by earnings by 2021. What’s there to not like?
The trouble with the argument for cheapness, as I see it, is that people have been using it for years. Yet the valuation ‘anomaly’ never seems to correct. At least not in the way that many people are probably hoping for – namely, by a re-rating of the valuation and an uplift in the share price.
Indeed, the share price has been swinging up and down for around a decade, but the overall direction of travel has been sideways. And that movement has happened despite generally improving trading and finances over the period. Why hasn’t the share price been creeping up to reflect that operational progress? I reckon the answer to that question is because the valuation has been creeping down instead.
The stock market is being rational
And the stock market is being rational by adjusting the valuation ever lower, in my view. Earnings look toppy to me and they’ve been high for some time. My guess is the market has been preparing for the next cyclical economic downturn ever since Lloyds’ profits recovered after the last one. Indeed, the banking sector is among the most cyclical of all sectors and, to state the obvious, profits tend to cycle lower after they’ve been high!
Maybe the COVID-19 outbreak will escalate sufficiently to send the world into recession. If that happens, there’s a decent chance that Lloyds profits, dividends and the share price will all plunge together, handily restoring the valuation to ‘normal’ levels. Indeed, bank stocks can be among the first to sink in a full-blown economic slump.
For me, the high dividend yield isn’t worth collecting because I fear the possibility of giving all my income gains back in capital losses. So I view Lloyds as a bargepole-job and won’t be buying any of the shares any time soon, despite those tempting-looking valuation indicators.
The post Lloyds is down big and the yield is high. Is it time to buy? appeared first on The Motley Fool UK.
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Kevin Godbold has no position in any share 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 2020