I don’t know of any well-known UK stock that seems to divide the opinion of investors more than Lloyds Banking Group (LSE: LLOY).
Bull versus bear
The bull argument appears to run along the lines that the stock looks cheap against the usual valuation measures. And the dividend yield is high. What’s more, it’s a well-established stalwart of the UK’s lead index and one of the countries largest public blue-chip businesses.
And on top of all that, the interest environment has been low for years, but rates appear to be on the rise. And banks can do well when interest rates are higher. Also, banks tend to thrive when the economy prospers.
So with the pandemic beginning to lose its grip, we could see brighter economic times ahead. And that would be ideal for helping the Lloyds business to grow.
However, I find the bear argument to be more compelling. And, for me, it starts with the observation that Lloyds operates a highly cyclical business. It’s super-sensitive to changes in the economic outlook and to investor sentiment. Profits, dividends and the share price tend to cycle up and down over the months and years with depressing regularity. And periods of high earnings often lead to lower earnings around the corner. So when earnings have been high for some time, there’s often a lot of risk to the downside for the stock.
And that last point is what worries me the most, because earnings have indeed been high since around 2016. But in that assessment, I’m ignoring the temporary effects of the pandemic. On top of that, I’m discounting the bull case for the stock being attractive because of a low valuation. To me, ultra-cyclical companies are ‘supposed’ to have a low valuation when they appear to be near the top of their earnings cycles.
A strong UK stock
So, on balance, I’m ignoring Lloyds Banking Group and see more attractive investment opportunities elsewhere, such as with Smurfit Kappa (LSE: SKG). The company operates as a paper-based packaging maker. And it’s been investing for growth while riding a tsunami of demand. And that’s being driven by the e-commerce sector and a shift in the market to paper-based packaging for sustainability.
City analysts are upbeat about the prospects of the business. They’ve pencilled in double-digit percentage increases for earnings this year and in 2022. And chief executive Tony Smurfit said in July: “We are accelerating our investment plans to capitalise on the significant growth opportunities available to us.”
Yet, despite the firm’s progress, the share price has weakened recently. It’s true that the operation has been facing rising input costs because prices for many things have been going up. But Smurfit Kappa has been good at raising its selling prices to preserve profit margins.
Meanwhile, with the share price near 3,921p, the forward-looking earnings multiple is just over 14 for 2022. And the anticipated dividend yield is around 2.8%. That’s not a bargain valuation and the stock price could slide lower if the company fails to meet its earnings estimates.
Nevertheless, I’m tempted to buy a few shares of Smurfit Kappa because the business looks strong to me.
Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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