Stop! Lloyds Banking Group plc could be a value trap
Tempting as it is to believe that Lloyds Banking Group's (LSE: LLOY) apparent low valuation will drive the shares up in the short term, I'm cautious.
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To me, there's a lot of risk to the downside for investors in Lloyds and the bank is ringing alarm bells.
Where's the growth?
Nobody is expecting Lloyds to grow its revenue or its earnings in the immediate future. Both seem to have reached a plateau after the bank recovered its profitability following the financial crisis.
This table shows Lloyds' financial results for the past two years and where City analysts think the bank is going over the next two. There really is nothing to get excited about:
Year to December | 2014 | 2015 | 2016 | 2017 |
Revenue (£m) | 29,892 | 23,150 | 17,941(e) | 18,217(e) |
Earnings per share (EPS) | 8.1p | 8.5p | 7.58p(e) | 7.74p(e) |
EPS growth | 23% | 5% | (11%) | 2% |
During 2014, earnings surged by 23% but that now looks like the tail end of the firm's post-crisis profit recovery from a lossmaking state. The shares had already factored-in that earnings recovery by the end of 2013. Since then the share price has drifted down from its peak of around 80p, standing at 65p as I write.
What is it?
And why shouldn't the share price fall back? The table shows that the bank isn't a fast-grower. It isn't even a stalwart or a slow-grower. Perhaps I should label it as a no-grower, but it isn't that either. Worse than any of those classifications, Lloyds is a cyclical and that makes the firm a dangerous 'investment' to hold.
The time to own Lloyds shares was when the company was posting losses, not paying a dividend, and after the price had collapsed to around 22p. Piling-in at the end of 2011 would have served investors well as the shares then climbed to the 80s over the next two years, anticipating the firm's recovery in earnings. But that recovery has happened and further growth seems set to be hard to gain if it comes at all. The firm faces regulatory headwinds, growing competition in its home market in Britain and a collapse in previously high-earning business lines based around financially geared speculation.
Conditions are all wrong
Right now, conditions are opposite to those prevalent when an investment in Lloyds worked well. Now the firm is posting high profits, it's paying a chunky dividend, and the shares are well up from their lows.
For investors with an eye on cyclical firms like Lloyds, that's all bad news. Lloyds has an apparent low valuation for a reason -- the market is trying to anticipate the next cyclical profit collapse. The market will fail to adjust sufficiently, of course, and when earnings plummet so will the shares, and that's the big risk involved in owning Lloyds shares now.
Cyclical firms such as Lloyds make poor buy-and-forget investments. We can make a fast gain catching the up-leg of a trading cycle, but that's been and gone. Right now, I think Lloyds is at its most dangerous because it looks at its most attractive in terms of valuation. I think the firm is likely to be a value trap and the alarm bells ringing the loudest are the absence of earnings growth and the juicy-looking valuation.
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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
