How long will it take Lloyds Banking Group plc's shares to recover?
Shares in Lloyds Banking Group(LSE: LLOY) peaked in January 2014 around 86p. Since then the performance of the shares has been disappointing for investors and today they stand some 30% lower at 56p.
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How long will it take Lloyds to recover from here? Well, I'd argue that Lloyds' business has already recovered from the lossmaking depths it plunged to in the aftermath of last decade's credit-crunch.
Robust profits
Back in 2007, pre-tax profit came in at around £4bn for the year. Then we saw gargantuan losses from the firm for a few years, but City analysts following Lloyds expect a pre-tax profit around £6.3 bn for 2016.
That looks like the business has recovered, but the share price is unlikely to ever return to the heady heights it occupied before the financial crisis. In 2007, the firm's profit delivered earnings per share of 58p. In 2016, with profit up almost 60% since 2007, the earnings-per-share figure looks set to come in at just 14p or so. Such are the effects of dilution where the profits must be distributed among a much larger share count.
Share prices don't tend to move according to absolute levels of profit, but they do move if the earnings-per-share figures rise. If a firm keeps diluting its investor base, as Lloyds has done in recent years, the shares will struggle to rise even though the underlying business might be doing well.
Barriers to shareholder gains
Yet dilution isn't the only worry for shareholders. Lloyds is busy shrinking its asset base and refocusing operations on the competitive UK market. Further business growth from here is likely to be hard to achieve, and I reckon the combined effects of further dilution and lacklustre profit growth could conspire to hold the shares back in the coming years. City analysts predict a 1.6% uplift in pre-tax profit for 2017 but a decline in earning-per-share of 16% this year and 8% during 2017.
But Lloyds' biggest disadvantage is its cyclicality. Some firms provide goods and services that are so stripped-back and of such a commodity nature that they're super-sensitive to macroeconomic events and cycles. Banks are like that. They provide a service that facilitates business and personal finance activity. If that activity declines, such as during a recession, so does the turnover of banks. That can lead to a dramatic and sudden plunge in earnings for the banks, and where earnings go the share price is bound to follow.
I think Lloyds' cyclicality is a big problem for those hoping for a valuation rerating now. The bank might look cheap on conventional valuation measures -- such as the level of the dividend yield and the price-to-earnings ratio -- but Lloyds deserves its low rating at this mature stage in the macroeconomic cycle, as viewed back to the credit-crunch. Profits have recovered and now look peaky to me. The cycle will turn at some point and the market knows it, that's why the valuation is low, in anticipation of the next business collapse.
Avoiding losses
The most important aspect of successful investing is avoiding losses, I'd argue. Buying shares in low-rated cyclicals after a period of robust profits, such as now with Lloyds, strikes me as a dangerous strategy. It may work out, but there's a good chance of your investment going down with the cyclical ship too.
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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.
