Should Lloyds Banking Group PLC's Shareholders Prepare For Another 20% Drop?

Bank shares have been punished relentlessly this year and Lloyds(LSE: LLOY) is no exception. Indeed, the bank's shares have fallen by 20% year-to-date, underperforming the wider FTSE 100 by a staggering 10%.

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And it's impossible to say if Lloyds' shares will fall further. A few months ago almost nobody would have predicted that the shares of one of the UK's largest banks would fall 20% in just six short weeks, but it has happened.

However, away from the stock market, Lloyds is still powering ahead. While the bank's shares could fall another 20%, depending on wider market trends, investors should concentrate on the underlying performance of the bank's business before selling up.

Underlying growth

As one of the UK's largest banks, and the UK's largest mortgage lender, it's possible to gauge Lloyds' success by looking at underlying lending trends for the UK economy. For example, according to Trading Economics the number of loan approvals for house purchase in the UK increased to 70,840 in December 2015, better than market expectations and higher than the reported 70,420 in November.

What's more, the number of approvals for remortgaging during December was 41,708, higher than the six-month average of 39,540, and the number of approvals for other purposes was 12,258, compared to the average of 11,725. In other words, the UK consumer is still borrowing, which is great news for Lloyds.

Also, Lloyds is set to benefit from the low oil price as consumers save, or pay down debt with the money saved from lower fuel prices. Then there's the UK housing market to consider. The market is still growing and average selling prices are increasing, which is once again only good news for Lloyds and the bank's loan book.

No reason to panic

Lloyds' underlying business is performing well and based on the strong performance of the UK economy, it's possible that Lloyds' earnings could continue to expand next year. City analysts expect the group to report earnings per share growth of 3% for full-year 2015 but current forecasts are also suggesting that earnings are set to fall by 8% during 2016. While this is disappointing, even accounting for an 8% fall in earnings, Lloyds is trading at an attractive 2016 P/E of 9.6.

Then there's the bank's dividend potential to consider. Lloyds is planning to ramp up its capital return to investors over the next few years. The bank is already sitting on more capital than regulators demand, and the group is targeting an ordinary dividend payout ratio of at least 50% of sustainable earnings. Based on this objective, analysts have pencilled-in a dividend payout of around 5.6p per share for 2017 -- a yield of almost 10% based on current prices.

The bottom line

Overall, Lloyds shares may fall further in the near term but the bank's underlying business continues to produce results and the shares are set to support a yield of 10% by 2017.

Income investments like Lloyds are the perfect way to build wealth over the long term. By reinvesting the dividends received from such investments, you can compound your money steadily without much effort at all.

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Rupert Hargreaves 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.