Do Rolls-Royce or Lloyds shares offer the better value?
Lloyds Banking Group (LSE:LLOY) is believed to have more shareholders than any other UK company. And with £24.9bn of trades so far this year, Rolls-Royce Holdings (LSE:RR.) is the seventh-most popular share on the London Stock Exchange.
On this basis, I think itâs fair to say that these two FTSE 100 companies are among the UKâs favourites. But which looks to offer the better value? Letâs see.
Apples and oranges
With this exercise, we are not comparing like with like. In theory, this shouldnât make much difference. After all, £1 of profit made by a bank is the same as £1 of earnings from a group specialising in civil aviation, defence, and power systems.
But the market views things differently. Among other things, investors look at the growth potential, risk profiles, and debt levels of various industries when determining valuations. Thatâs why a conventional bank like Lloyds has a trailing 12-month price-to-earnings (P/E) ratio of 13.2, whereas Rolls-Royce, with its clever technology, is valued at 51 times its 2024 profit.
It therefore makes sense to compare both to their closest peers. But the diversified business model of Rolls-Royce is unique so itâs hard to find an equivalent. However, compared to the two defence contractors on the FTSE 100 — BAE Systems and Babcock International Group — its shares are much more expensive.
And as the table below shows, looking at the earnings of the Footsie’s banks relative to their market caps, Lloyds is the dearest.
| Bank | P/E ratio |
|---|---|
| Lloyds Banking Group | 13.2 |
| Barclays | 8.8 |
| NatWest Group | 8.7 |
| Standard Chartered | 7.5 |
| HSBC | 6.9 |
| Average | 9.0 |
This doesnât really help much.
We could consider their balance sheets but, generally speaking, investors tend to prefer earnings. A good example of this is Rolls-Royce itself. At 30 June, it had a book value (assets less liabilities) of £2.4bn. But its current (21 November) market cap is around £85bn.
Analysts view both stocks as undervalued. The 12-month share price target for Lloyds is 13.8% higher than todayâs. For Rolls-Royce it’s 15.8%. The difference is too small to be meaningful.
Future potential
As important as numbers are, whether a stock offers good value or not is often a matter of opinion.
Analysts are expecting big things from Lloyds over the next couple of years. They reckon earnings per share in 2027 could be 79% higher than in 2024. And its above-average dividend is likely to appeal to income investors. Also, with a 20% share of the UK mortgage market, it could do well if the property sector continues its recovery. However, itâs heavily exposed to the UK economy, which appears fragile at the moment. And thereâs continuing speculation that higher taxes might be imposed on the sector in this monthâs Budget.
As for Rolls-Royce, analysts are forecasting a 110% increase in earnings by 2028 versus 2024. Looking further ahead, there could be further gains from small modular reactors and a return to the narrowbody aircraft market. Data centre growth could also help its power systems business. But the pandemic highlighted how vulnerable the group is to a downturn in the aviation market. And its dividend is tiny.
On balance, I think Rolls-Royce has more long-term potential than Lloyds. It has greater international exposure and three distinct divisions. This means risk is spread more widely. Thatâs why I think itâs worth considering. However, I admit it’s not the cheapest stock around.
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HSBC Holdings is an advertising partner of Motley Fool Money. James Beard has positions in Babcock International Group Plc, Barclays Plc, and Rolls-Royce Plc. The Motley Fool UK has recommended BAE Systems, Barclays Plc, HSBC Holdings, Lloyds Banking Group Plc, Rolls-Royce Plc, and Standard Chartered Plc. 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.
