Why you should -- and shouldn't -- buy Lloyds Banking Group plc

Lloyds Bank branch

Today I am considering the perks and the pitfalls of investing in Lloyds Banking Group plc (LSE: LLOY).

Is British best?

Fears over the health of the UK economy continue to subdue investor appetite for Lloyds.

Massive asset shedding makes the bank dependent on the financial health of its home market -- and more specifically the British high street -- so signs of cooling domestic economic growth is doing little to help investor appetite. And of course the run-up to June's 'Brexit' referendum is casting a further pall over Lloyds' revenues outlook.

On top of this, Lloyds' decision to concentrate on its UK retail operations leaves little room for the firm to generate explosive earnings growth in the long term, unlike many of its competitors like HSBC and Santander, which boast significant emerging market exposure, for example.

Simply wonderful

However, the sterling achievements of Lloyds Simplification cost-cutting progress in boosting the bottom line certainly merits attention.

Lloyds saw operating costs drop 2% during January-March, to just under £2bn. This prompted the bank to note that

"Phase II of the Simplification programme has now delivered £495m of annual run-rate savings to date, ahead of plan and on track to deliver £1bn of Simplification savings by the end of 2017."

The company's cost-cutting plan clearly has plenty left in the tank.

PPI pains

A major problem that continues to dog the entire banking sector is the likely scale of further penalties for the mis-selling of payment protection insurance (PPI).

In a rare ray of sunshine, Lloyds was not required to set aside further capital to cover the cost of the scandal during January-March, the bank advising that "complaint levels over the three months have been around 8,500 per week on average, broadly in line with expectations."

That is not to say that additional provisions will not be made in future, of course. Lloyds has already stashed away £16bn for previous misconduct, and many commentators expect this bill to continue rising.

Indeed, Standard and Poor's estimated last month that Lloyds, HSBC, Barclays and RBS will have to pay out an extra £19.5bn collectively in 2016 and 2017, taking total compensation for conduct and litigation issues since 2011 to £55.8bn.

Going for a song

Still, it could be argued that the risks facing Lloyds are currently factored into the share price.

Sure, the bank may be expected to swallow an 11% earnings decline in 2016. But this results in a P/E rating of just 8.8 times, well below the bargain benchmark of 10 times. And this reading falls to 8.7 times for next year, thanks to a predicted 2% earnings rise.

And of course dividends are expected to get flowing at Lloyds from this year onwards. A projected 4.4p per share payout for this year creates a market-smashing 6.6% yield. And expectations of a 5.2p reward in 2017 drives the yield to an astonishing 7.7%.

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Royston Wild has no position in any shares mentioned. The Motley Fool UK has recommended Barclays and HSBC Holdings. 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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