Why Lloyds stock has a lot of room to run in 2021

Motley Fool contributor Chris MacDonald casts his eye over Lloyds stock, and finds much to like in the British banking giant.

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As far as the biggest and best players in the U.K. banking space go, Lloyds (LSE:LLOY) is a company that many investors have on their watch list right now. After all, Lloyds stock remains a polarising equity among many investors.

Bulls and bears remain divided, largely on macroeconomic factors. As a major bank and an economically sensitive stock, this makes sense.

Let’s take a look at the bull and bear case on this stock.

Bears: Lloyds stock overvalued based on over-exuberance in the markets

Fellow Fool contributor Royston Wild pointed out three key headwinds for Lloyds stock in a recent piece. I think these are spot on.

Wild noted that prolonged Covid-19 restrictions in the U.K., interest rates remaining ultra-low for longer, and Lloyds’ lack of international exposure could result in underperformance for some time.

Indeed, these headwinds are worthy of investors’ attention right now. Assuming the market has gotten it wrong and priced in too much exuberance into Lloyds stock, the worry is that we could be headed for a significant period of decline in such an environment.

Of course, the market tends to overreact in the short term, and get it right over the long term. The question remains how long such a repricing would take, and how much pain investors might see over this time frame.

Bulls: headwinds largely overblown

The reality is that pandemic restrictions may remain in place longer than we may like in the U.K. Accordingly, the fact that the pandemic reopening thesis is taking a breather with many large-cap U.K. stocks makes sense.

It’s also true that Lloyds is more sensitive to U.K.-specific headwinds. This banking giant is more domestically oriented, for better or worse.

Furthermore, given the inflation data we’ve seen from the Bank of England, the view that interest rates could stay lower for longer makes sense. After all, domestic inflation isn’t as high as what we’re seeing in the U.S. However, expectations are that the Bank of England doesn’t want to let inflation overshoot its 2% target for long. With inflation now slightly above the 2% level, rate hikes appear to be on the horizon.

The view among many bulls is that this recent selloff likely represents short-term noise in a longer-term reopening thesis. Stocks are forward-looking, and on this basis, if the market believes these pandemic-related issues may be resolved, say, by the end of the year, we may see a continuation of the bullish price action in Lloyds stock that has taken it approximately 35% higher over the past month.

Bottom line

My view on Lloyds stock is that this is a fairly valued bank. Relative to international peers in the U.S., Lloyds actually trades on the higher-end of the valuation multiple spectrum.

However, I tend to side with the bulls on Lloyds. There’s a lot to like about this lender’s exposure to the U.K right now, and I’m contemplating buying shares in the company for my own portfolio.  

I believe U.K.-focused banks such as Lloyds provide greater leverage to the reopening thesis taking these stocks higher. In other words, I think we’re in the early innings of a nice reflation trade.

When the economy eventually reopens (and it will), Lloyds will be a key beneficiary. And so will investors.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Chris MacDonald 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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