3 things you need to know before buying Lloyds Banking Group plc

Lloyds Banking Group (LSE: LLOY) shares may still be worth 130% more than they were at the end of 2011, but they've fallen by 20% this year. I believe it's worth considering why the shares have fallen, and whether this is a buying opportunity.

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In this article, I'll highlight three factors that could cause Lloyds' share price to move sharply higher in 2017.

Government share sales

Chancellor Phillip Hammond has abandoned his predecessor's plans for a discounted offering of Lloyds shares to retail investors. Instead, he's decided to simply drip feed stock into the market, in order to generate as much cash as possible without further delay.

One side effect of this plan is that the so-called overhang of unsold government stock is keeping Lloyds' share price down.

Big investors know that the Treasury has another 8% of Lloyds to sell. Anyone wanting to buy a big pile of shares doesn't need to bid up the share price. All they need to do is wait until the Treasury's stock broker feeds some more stock into the market.

This overhang means that Lloyds' share price is likely to remain weak until the government has finished selling its stock. But once the sale is complete, a more limited supply of stock for sale could push up the price.

Expansion plans

Lloyds passed the recent Bank of England stress tests with flying colours. The group's so-called CET1 ratio of 14.1% is well above the minimum required. This means that Lloyds should be able to afford to raise the dividend next year.

A high level of surplus capital also means that the bank's executives are in a position to consider making acquisitions. Recent reports in the Financial Times suggest that Lloyds is considering a £7bn deal to buy the UK arm of the MBNA credit card business.

The attraction of this potential deal is that it would lift Lloyds' share of the UK credit card market from about 15% to more than 25%. The disadvantage is that it could come at a time when interest rates may be about to rise, potentially triggering an increase in bad debt levels.

Historically, credit cards are profitable and relatively trouble-free operations. So a successful deal could help support earnings growth, which looks weak at the moment.

The question about earnings

Indeed, one of the main reasons for Lloyds' poor performance this year is that the outlook for earnings is poor. Consensus earnings forecasts for 2016 have fallen by 6% over the last year, from 7.72p per share to 7.23p per share.

Earnings are expected to fall by a further 8.5% to just 6.6p per share in 2017. Today's share price reflects expectations about future earnings, so it's not surprising that the shares have slipped steadily lower this year.

However, investors may soon start to see value in Lloyds shares. The bank now trades on a 2016 forecast P/E of 8.1, and offers a prospective yield of 5.4%. In my view, this valuation is cheap, without being alarming.

The factors I've listed in this article could combine to boost Lloyds' earnings and lift the group's share price over the next year or so. But Lloyds could equally face a profit-sapping housing slump, and a slowdown in consumer spending. Ultimately, it's your call.

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Roland Head 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.