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Will the Lloyds share price ever return to 63p?

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Lloyds (LSE: LLOY) shares have been an incredibly disappointing investment to own over the past five years. Over this half-decade, shares in the lender have declined nearly 15%, excluding dividends.

Including dividends paid to investors, the stock has returned just 0.6% a year. That’s compared to a return of 4.7% for the broader UK market.

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When the coronavirus pandemic struck the UK economy, shares in the company plunged from 63p to 27p, and they continued to decline throughout 2020. The Lloyds share price hit a multi-year low of 24.7p at the end of September 2020. 

Economic lockdown

Investors were selling the stock last year because there were genuine concerns that the lockdowns the government introduced to try and control the spread of coronavirus would decimate the economy and set off a banking crisis. Luckily, this worst-case scenario never materialised, although the lockdowns did cause significant harm to the economy. 

Lloyds managed to navigate the crisis relatively well, and today it’s emerging at the other side of the tunnel. While the group’s suffered some damage, it’s benefited from booming mortgage demand and lower-than-expected loan losses. 

And now the group’s primed to capitalise on the UK economic recovery. However, it doesn’t look as if the market believes the company can make the most of this recovery. The stock’s still trading at a discount to its year-end 2020 level of 63p.

With that being the case, I wonder what could be the catalyst to help the Lloyds share price return to 63p. 

Lloyds share price valuation

For the lender’s 2019 financial year, it reported earnings per share of 4p. At 63p, that implies the stock was dealing at a forward price-to-earnings (P/E) multiple of around 16.

As the group would have reported its results for 2019 in the first half of 2020, this valuation would have reflected the market’s optimism in the banking organisation. 

Today, the stock’s trading at a P/E multiple of around 7. This seems to suggest the market doesn’t believe the firm will generate sustainable growth. If it did, the valuation might be closer to that achieved at the end of 2019. 

That being said, the valuation figures only provide a rough guide of market sentiment and company valuation. Just because a stock traded at a particular valuation at one point doesn’t mean it’ll ever achieve this valuation again. 

Growth potential

Still, this gives us some idea about the market’s view of the Lloyds share price. It seems as if investors are worried about its growth potential. That’s understandable. 

Over the past decade, interest rates have trended steadily lower. At the beginning of the pandemic, central banks worldwide dropped them to their lowest levels in recent history. While the industry didn’t immediately pass these rates on to consumers, banks’ valuations didn’t take long to reflect lower rates. 

At the core of any bank’s business model is the so-called interest rate spread. This is the difference between what it can charge to borrowers and pay lenders. If interest rates increase, the spread tends to widen. However, if rates fall, the spread can collapse. 

That’s what has happened across the banking industry over the past 24 months. Lenders have slashed interest rates on products, and consumers have benefitted. 

Looking for profits

This has made it harder for lenders like Lloyds to earn a profit, although the bank has been able to navigate this storm, thanks to its credit card business.

The acquisition of credit card group MBNA several years ago has helped the lender maintain its overall interest rate spread as it’s been able to charge credit card borrowers a higher rate of interest.

Nevertheless, it seems as if the market’s not giving the Lloyds share price any credit for this diversification.

Instead, investors seem to be waiting for evidence that interest rates will increase from current levels. This would help push up borrowing costs across the sector and may allow Lloyds to earn a higher profit. 

Lloyds share price outlook

The good news is, it’s starting to look as if interest rates may start going up in the next six to 12 months. This could be the positive news flow the market’s looking for. It will undoubtedly allow Lloyds to increase interest rates charged to consumers, which would help bolster the bottom line. 

A brighter outlook may force the market to revisit its view of the enterprise, and this could lead to a re-rating of the stock. 

However, this is far from guaranteed. There’s no guarantee interest rate will increase in the next six to 12 months, and there’s no guarantee the market will re-rate the Lloyds share price to a higher multiple. 

There are plenty of risks on the horizon that could even destabilise its recovery. These include another pandemic lockdown and so-called stagflation, an economic phenomenon where economic growth grinds to halt, but prices continue to rise. In this scenario, demand for the group’s following products could drop. So could its earnings. 

Buy, sell, or hold

Considering all of the above, I think the Lloyds share price can potentially return to 63p, although I can’t put a date on when this will happen. 

As the UK economy returns to growth, I think interest rates will increase, boosting the lender’s profits. At the same time, it should benefit from an increase in demand for lending products. 

As such, despite the risks outlined above, I’d buy the stock for my portfolio today. I think it’s one of the best ways to invest in the UK economic recovery without taking on too much risk, thanks to its blue-chip status. 

I also think that the group may return significant amounts of cash to investors via dividends as profit growth returns.  

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Rupert Hargreaves 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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