Lloyds share price: why this FTSE 100 bank is on my February watchlist

The Lloyds (LSE: LLOY) share price has underperformed the FTSE 100 index so far this year. The shares are down 7%, while the index is up 1%.

The short-term performance of the stock has been disappointing, but could it have a brighter future? Here, I’ll discuss why Lloyds is on my February watchlist.

The Lloyds share price in perspective

I don’t take too much notice of short-term performance. But as the table below confirms, Lloyds has delivered poor returns (including dividends) over significantly longer periods too.

Clearly, this isn’t a good look. However, while I don’t dismiss past performance entirely, I’m far more interested in where Lloyds’ business and share price are now, and where they could be in the future.

Profitable and financially strong

The last business update from Lloyds was its third-quarter statement, issued on 29 October. It posted a forecast-beating £1bn pre-tax profit. This was a big turnaround from a ghastly second-quarter loss of £0.7bn.

Thanks to the improved financial performance, Lloyds was able to further strengthen its capital position. It ended the quarter with a Common Equity Tier 1 ratio of 15.2% versus a regulatory minimum requirement of 11%.

In short, the third-quarter update showed the ‘Black Horse’ as a profitable and financially strong bank. On the face of it, the current Lloyds share price appears to undervalue the business.

Lloyds share price versus asset value

At 34p, Lloyds’ shares are priced at just 0.65 times the tangible net asset value of 52.2p per share it reported at the third-quarter end. Put another way, buyers today are paying 65p for every £1 of Lloyds’ assets — assets that produced a £1bn profit in the last reported quarter.

Of course, since then, we’ve had a resurgence of Covid-19 cases, worrying mutations of the virus, and a renewed lockdown of large parts of the economy. There’s a risk Lloyds’ current attractive-looking asset valuation could collapse in the event of a protracted pandemic of virus variants and a deep recession.

Lloyds is on my February watchlist, because its annual results are scheduled for the 24th. We’ll get to see the fourth-quarter numbers. We’ll also get some commentary on post-year-end business and the outlook for 2021. Additionally, we should get clarity on the dividend, and guidance on the payout policy going forward.

Dividends set to return

In December, the Prudential Regulation Authority announced it’s allowing banks to resume paying dividends “should their boards choose to do so.”

It said that “in relation to full-year 2020 results,” distributions “should not exceed the higher of: 20 basis points of risk-weighted assets as at end-2020; or 25% of cumulative eight-quarter profits covering 2019 and 2020 after deducting prior shareholder distributions over that period.”

It also said that if a bank wishes to make distributions “in excess of these guardrails,” it can expect “a high bar for justifying any exceptions.”

City analysts — and most of us at the Motley Fool — are expecting Lloyds to declare a dividend. I reckon the level at which the board sets it will give us a good idea of management’s confidence in the business outlook.

This, and the yield on the dividend, should further help me judge how much value I think there is in Lloyds at the prevailing share price.