Should I Invest in Lloyds Banking

LONDON -- To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment, and as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.

To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.

Quality and value
If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.

So this series aims to identify appealing FTSE 100 investment opportunities, and today I'm looking at Lloyds Banking Group  (LSE: LLOY  ) (NYSE: LYG  ) , the U.K.-focused financial services and banking company.

With the shares at 62 pence, Lloyds' market cap. is £43,874 million.

This table summarizes the firm's recent financial record:

Year to December 2008 2009 2010 2011 2012
Revenue (£m) 16,195 45,297 44,044 26,843 38,906
Net cash from operations (£m) 33,841 (33,735) (2,037) 19,893 3,049
Adjusted earnings per share (p) 10.1 7.5 (0.5) (4.1) (2)
Dividend per share (p) 11.4 0 0 0 0

In recent news, Lloyds has agreed to the sale of a portfolio of U.S. residential mortgage-backed securities (RMBS), which it expects will bring in £1.4 billion and generate a pre-tax gain on the assets of around £540 million. One of the firm's pension schemes is selling U.S. mortgage assets, too, expected to result in a £360m gain to help reduce the pension scheme deficit.

The deals are the latest in a long list of non-core asset disposals designed to bolster Lloyds' tier 1 capital ratio. This transaction will add about £1,400 million of capital, or about 47 basis points to the ratio, which was running at about 12.5% at the end of April.

The debilitating effects of banking's long financial winter clearly show in the firm's financial record. Lloyds intensified those effects when it took one for team-U.K. by agreeing to acquire HBOS in the depths of the financial crisis in early 2009, as Britain's economic system seemed set to collapse. At the time, HBOS seemed like a black hole of potentially toxic mortgage assets.

But recent progress with the balance sheet should provide a robust platform for growth from here. First quarter results were encouraging with a 198% period-on-period increase in underlying operating profit to £1,479 million, which makes me optimistic about the firm's potential to deliver on total returns.

Lloyds' total-return potential
Let's examine five indicators to help judge the quality of the company's total-return potential:

1. Dividend cover: ironically, a zero dividend has excellent cover from earnings! 5/5

2. Borrowings: net borrowings are around 1.8 times net assets. 2/5

3. Growth: recent growth in revenue, earnings and cash flow has been encouraging. 4/5

4. Price to earnings: a forward 11 or so compares well to growth and yield expectations. 4/5

5. Outlook: good recent trading and a positive outlook. 5/5

Overall, I score Lloyds 20 out of 25, which encourages me to believe the firm has the potential to out-pace the wider market's total return, going forward.

Foolish summary
The firm scores well on my quality and value indicators, although investors will welcome the reintroduction of dividend payments, which seems like a possibility given rising balance-sheet strength and improving profits. I'm already holding Lloyds shares but they remain tempting and I might buy more.

But there is still uncertainty around Lloyds, especially when compared to the companies featured in "5 Shares To Retire On," a new Motley Fool report prepared by our top analysts highlighting five shares with seemingly impregnable, moat-like financial characteristics. They are shares that deserve consideration for any investor aiming to build wealth in the long run. For a limited period, the report is free. To download your copy now, click here.


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