Towards the end of last year, I called sell on Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US). In my view, the UK-focused bank was already fully valued, and better opportunities were available elsewhere.
Was I wrong?
As an investor, its sometimes worth taking a fresh look at a firms valuation, in order to try and understand it better.
A classic value investing technique is the PE10 valuation a version of the P/E that divides a companys current share price by the firms average earnings per share (eps) over the last 10years.
The PE10 smooths out yearly fluctuations in profits, and can be a good way to highlight good companies that are going through a bad patch.
Lloyds PE10 is 3.6!
From 2004-2008, Lloyds made bumper profits. Profits fell in 2009, and the bank reported a loss every year from 2010 until 2013.
However, such were the size of Lloyds 2004-8 profits, that even allowing for four consecutive years of losses, Lloyds has ten-year average eps of about 20p, giving a PE10 of about 3.6 an amazingly low figure.
Is Lloyds a buy?
Lloyds finances look fairly strong. The banks common equity tier 1 ratio, a key regulatory measure of a banks ability to absorb losses, rose from 10.3% at the end of 2013 to 12.0% at the end of September 2014.
City investors tend to view 10% as a key safety level, so this was good news. However, the big question is whether Lloyds profits can ever return to pre-crisis levels.
In 2007, Lloyds reported peak annual earnings of 58p per share. I dont think well see that level of profit again for at least a decade, but I reckon that the banks 2008 earnings of 14p per share are a realistic medium-term target.
The latest City forecasts for 2015 suggest Lloyds could report earnings of 8.2p per share this year. If the wider UK economy continues to recover, then I reckon that over the next 2-4 years, Lloyds earnings per share could rise to between 10p and 15p.
This would put the banks shares on a prospective P/E of between 5 and 7, at todays share price, suggesting a buying opportunity.
Was I wrong about Lloyds?
I no longer think that Lloyds shares are too expensive, but the lack of a reliable dividend is still a problem for me we dont yet know when Lloyds will be allowed to restart dividend payments.
In my view, there are still better buying opportunities elsewhere in today’s market.
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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.
