The governments disposal of its last remaining shares in bailed-out Lloyds (LSE: LLOY) on 16 May represents a significant milestone in the banks rehabilitation since the financial crisis.
And with long-time banks bear Neil Woodford also announcing this month that hes taken a stake in the business, the company appears to be an increasingly attractive investment proposition.
Could legendary US investor Warren Buffett join the UKs most celebrated fund manager in backing Lloyds?
The FTSE 100 bank has a market cap of over 50bn, so its certainly big enough to enable Buffett to buy a worthwhile stake in the business. But does it have characteristics that might appeal to hiseye? Furthermore, is the current valuation attractive?
Buffetts biggest holding in the financial sector and his number two holding overall is Wells Fargo. The bank has recently been involved in a scandal involving employees fraudulently opening customer accounts in order to meet cross-selling and sales targets. But the CEO has gone and Buffett is continuing to back the company. So, Lloyds past transgressions shouldnt present a stumbling block for him.
As the USs largest retail mortgage lender, Wells Fargo provides a good yardstick to measure Lloyds against.
Returns and valuation
Its in the nature of banks that they have a low return on assets (ROA) of little more than 1% or 2% and achieve a decent return on equity (ROE) a double-digit percentage by financial leverage.
High leverage is great for enhancing ROE in boom times but can be disastrous in bad times. The table below shows key numbers for Wells Fargo and Lloyds going into the financial crisis.
Wells Fargo, with its relatively low leverage, was resilient through the financial crisis, while Lloyds fared rather less well to put it mildly. However, the UK bank has since moved more towards Wells Fargos profile. The table below shows trailing 12-month numbers for the two companies.
Lloyds returns are currently still depressed by the tail-end of its legacy issues, restructuring costs and so on. An effective tax rate of over 40% isnt helping either, but Lloyds expects this to normalise at around 27% (Wells Fargos is consistently around 31%).
In short, Lloyds could very soon be looking a lot like Buffetts favourite US bank. Furthermore, as the table below shows, the valuation of the Black Horse appears relatively attractive on several measures.
|Dividend yield (%)||2.9||3.5|
So, there could be good upside for Lloyds shares, if they were to re-rate closer to the valuation Wells Fargo commands.
Finally, Buffett could see Lloyds proposed acquisition of credit card firm MBNA as a good move, because he likes this area of the market. American Express is his fifth largest holding and he also has smaller stakes in Visa and Mastercard.
In summary, I think Lloyds emerging fundamentals and current valuation could have considerable appeal for him. Of course, whether he will actually invest isnt a question I can give a definitive answer to.