As penny stocks go, Lloyds (LSE: LLOY) is probably the biggest of the lot in the UK. Even though its share price is 46p as I write, its market value is a huge £33bn.
Does its low price make Lloyds a buy for my portfolio? I need to research the prospects of the business for the following year before I invest. Here’s what I think.
What I like about this penny stock
First, the Lloyds share price is up an impressive 36% over one year. This suggests that the business is performing well. Indeed, in the third-quarter interim management statement, the company said it recorded a profit before tax (PBT) of £5.1bn for the nine months to 30 September. This was a huge increase over the same period in 2020 when PBT was just £620m. But Lloyds’ management said the improvement in trading was due to the general improvement in the economic outlook so it wasn’t purely company-specific.
It’s understandable why profits have grown by such an extent. Lloyds earns income based on a net interest margin, or the difference in interest it charges compared to the interest it pays on deposits.
Therefore, profitability will improve when consumers are willing to loan money for things like mortgages, and on credit cards. The housing market has been particularly buoyant in 2021, which will have boosted the company’s profits. Also, as general sentiment improved after lockdowns ended, consumers will have been more willing to borrow.
I’m optimistic about the growth prospects of the UK economy heading into 2022, so I view this as favourable for Lloyds’ prospects.
Lastly, inflation is set to rise again in 2022. The Bank of England is forecasting consumer price rises to peak at about 5% in April. This might sound scary, but it also means the BoE will likely raise its base interest rate in 2022. For Lloyds, this may mean an even bigger net interest margin.
Risks to consider
As mentioned, Lloyds is able to generate profit from its lending activities. This was boosted significantly by the booming housing sector this year as the company expanded its mortgage book. However, it’s unlikely that this will continue into 2022 due to the end of the stamp duty holiday. House prices are also near an all-time high which may deter future buyers, and therefore borrowers.
Looking at the full-year forecast for PBT in 2022 and it’s expected to decline by 9% over 2021 to £6.8bn. This is still far larger than the £2bn of PBT that Lloyds achieved in pandemic-hit 2020. Nevertheless, the 9% reduction, I think, reflects the cooling of its lending activities after the boom this year.
Is this penny stock a buy?
Even though Lloyds’ profit is expected to decline next year, I still view the stock as attractively valued. On a price-to-earnings basis, the shares are priced on a multiple of 7 for 2022. I consider this dirt-cheap. The forward dividend yield is an impressive 5.3% too.
Taking everything into account, I view Lloyds shares as a buy for my portfolio. There are still risks to consider, but I think the shares are priced to reflect this going forward.
