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Is the Lloyds share price undervalued?

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The Lloyds (LSE: LLOY) share price looks cheap, compared to its trading history. Right now, the stock is selling in the market for around 43p, compared to the year-end 2019 level of approximately 64p. 

Research shows that buying shares trading at depressed levels can lead to positive returns in the long term, although success isn’t guaranteed. However, this is the approach I’ve been using to invest for many years.

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As such, I’ve recently been taking a closer look at the Lloyds share price to see if it’s undervalued and worth adding to my portfolio. 

Risks and challenges

Whenever I come across a business that looks cheap, I always try to understand why it’s cheap in the first place. With Lloyds, I think it’s relatively easy to understand the stock’s recent performance.

As one of the largest banks in the UK, the company’s success is tied to the country’s economy. Therefore, as the economy has struggled over the past 12 months, the group’s outlook has clouded. 

This is a significant risk that’s always going to hang over the Lloyds share price. If economic growth slows, it will reduce the demand for lending and could increase credit losses. These two factors will lead to lower profits for the banking group. 

However, I see opportunities on the horizon for the bank as well. As the UK economy starts to reopen, consumer confidence is growing. Initial indications show that consumers have been happy to spend the money saved over the past 12 months. On top of this, business confidence is also growing. These two factors could increase lending at Lloyds’ business bank, consumer bank and credit card business MBNA

All in all, I think the bank has faced some significant challenges over the past 12 months. But, with growth tailwinds building, I think there could be some tremendous opportunities for the company on the horizon. 

Lloyds share price value 

All of the above leads me to the conclusion that Lloyds shares could be undervalued. Looking at City growth projections, it seems as if analysts believe the group will earn 4.4p per share in 2021, and 5.1p in 2022. These are just projections at this stage. There’s no guarantee the company will hit these targets.

Nevertheless, I think they show the lender’s potential if growth returns over the next few years. If Lloyds can earn 5.1p in 2022, the stock is selling at a forward price-to-earnings (P/E) multiple of 8.6. That’s compared to the market average of 16. 

Based on these figures, I’d buy the stock for my portfolio today. It seems to me the Lloyds share price is undervalued compared to its potential over the next few years.

That said, this equity might not be suitable for all investors. Another wave of coronavirus could cause further economic pain and if the Bank of England has to drop interest rates below 0%, Lloyds’ profit margins could collapse. These are the primary risks and challenges facing the group right now. 

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Rupert Hargreaves owns no share 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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