In the midst of all the hand-wringing associated with the U.S. federal government shutdown and the fight over raising the debt ceiling, investors are rightfully looking elsewhere for opportunities that offer exponential returns from special situations that aren’t getting front-page attention from financial reporting outlets.
Among those enormously enticing themes that are operating under the radar is the bottoming-out of the European recession and what that means to a very bruised and battered banking sector, where assets trade at a fraction of pre-2008 levels. The course of intervention by the European Central Bank to provide fiscal stimulus is taking on the look of a 2.0 version of Fed’s QE road to economic recovery, yet its course is about two years behind that of the U.S.
One doesn’t have to go far to find rich values from banks trading at or near book value, in the midst of shedding non-core assets and paying back government bailouts, with private equity looking to buy those government-owned shares at current prices.
Of the major banks within the European region, my favorite is U.K.-based Lloyds Banking Group (LYG).
Lloyds has several catalysts working in its favor. The bank has been busily disposing of assets that it views as non-core — the latest being a $1.45 billion ($1.37 billion U.S.) disposition of Australian operations to Aussie banking giant Westpac (WBK). In addition, Lloyds said it hopes to pay out as much as 70% of earnings as a dividend by 2016, which as a high-yield editor, has my full attention. This puts shares on a prospective yield for 2016 of more than 7% if earnings come in as projected.
As to those projected earnings, the growth prospects for Lloyds are, quite frankly, quite bullish after all the cost cutting and paying of bailout funds. Earnings per share are forecast to grow by 25% in 2014 alone, making Lloyds one of the most attractive growth stocks in the FTSE 100 and poised to become another $5 stock that could see $20 by sometime in 2016.
Sound heady? Shares of LYG traded north of $45 in 2007, so by restoring 50% of its former pre-recession value, investors can realize a potential return of 300% before including any dividend income.
In the most recently published report of bank stress testing, Lloyds came out with the best ratios among its peers, this following last quarter’s better-than-expected earnings report that fueled a 10% jump in the common shares. I can’t help but to look at Bank of America’s (BAC) stock when it was trading at $5 just two years ago — it now sits above $14 after touching $15 before the budget battle ensued.
My view is that shares of LYG are in that very same place — down almost 90% from their pinnacle in 2007, the company ridding itself of assets that don’t bring immediate results to the bottom line, and the first wave of divestiture by the U.K. government already on the books. The U.K. sold a 6% stake in Lloyds for £3.2bn in September, and still holds a 33% stake.
The U.K. government plans to completely empty that stake before the next general election in 2015, leaving the door open for several more big-name institutions to make headlines. The template for getting into the leading banks as a major economic region starts turning the corner is in place, right here in the U.S.
As the political wrangling consumes the attention of the markets, smart money is quietly backing up the truck at the London Stock Exchange and loading up on Lloyds.
Bryan Perry is the editor of Cash Machine, a newsletter focused on high-yield income investing with the goal of maintaining a blended total yield of 10% across two portfolios. Bryan is also the editor of Extreme Income, which uses the power of historically cheap money to create a leveraged “baby hedge fund” strategy that paves the way to massive profits and 4x greater income.