This P/E Suggests Lloyds Banking Group PLC (ADR) (LYG) Is a Hold

I’m on the hunt for companies that still look cheap, based on their long-term earnings potential. To help me hunt down these bargains, I’m using a special version of the price to earnings ratio called the PE10, which is one of my favorite tools for value investing.
Today, I’m going to take a look at the PE10 for Lloyds Banking Group PLC (ADR) (NYSE:LYG).The PE10 compares the current share price with average earnings per share for the last ten years. This smoothes out any short-term volatility and lets you see whether a company looks cheap compared to its long-term earnings.

Have investors gotten ahead of themselves?

Since the U.K. government took a 39% stake in Lloyds in 2008, the bank’s share price has fluctuated wildly, but it has risen by 143% over the last year, taking it above the 61 pence threshold that the government claims is its break-even point.

Lloyds Banking Group PLC (ADR) (NYSE:LYG)’s management is confident that the bank will make a statutory profit this year, and its shares now trade around 12% above their tangible net asset value, unlike those of Barclays PLC (ADR) (NYSE:BCS) and Royal Bank of Scotland Group plc (ADR) (NYSE:RBS), which continue to trade at a discount to book value.

So does this mean that Lloyds’ recovery is complete, or have investors got ahead of themselves? Let’s take a look at Lloyds’ current price-to-earnings ratio, and its PE10:

	2013 Forecast P/E	PE10
Lloyds Banking Group	13.2	2.4

I was unable to calculate a trailing P/E for Lloyds Banking Group PLC (ADR) (NYSE:LYG)’s, as it made a loss last year, so I’ve substituted this year’s forecast P/E, based on City analysts’ forecasts.

The big difference between Lloyds Banking Group PLC (ADR) (NYSE:LYG) forward P/E of 13.2 and its PE10 of 2.4 shows the scale of the challenge that remains ahead of the bank. Can its earnings ever return to the 40p-plus earnings per share levels seen before the financial crisis?

Hold Lloyds
I think Lloyds is a hold at the moment.

Investors who bought the bank’s shares when they hit all-time lows in 2012 are sitting on a good profit, but Lloyds Banking Group PLC (ADR) (NYSE:LYG)’s forward P/E of 13 suggests to me that a lot of progress has already been priced into the shares, and that further gains in the near term are unlikely.

Given this, I think there are currently better opportunities elsewhere in the banking sector.

Mr. Woodford’s track record is impressive: if you’d invested £10,000 into his High Income fund in 1988, it would have been worth £193,000 at the end of 2012 — a 1,830% increase!