Lloyds (LSE: LLOY) shares have underperformed throughout the first half of 2022. Down 15% year-to-date, the share price is currently sitting at an underwhelming 42p. Broadening the time horizon to 12 months, Lloyds stock has fallen over 7% in value. In today’s weak market, I’m on the lookout for hidden gems – is Lloyds one of them? Let’s take a look.
A double-edged sword
Interest rates are rising in the UK and are pivotal for the way that Lloyds conducts its business. The Bank of England is raising rates to combat red hot inflation, which reached 7.9% year-on-year in May. Inflation has come after a boom in spending, mainly fuelled by the government’s fiscal stimulus to ease the pandemic’s economic impact.
Higher interest rates should slow down consumer spending. But while this should also slow down inflation, it can plunge the economy into recession. If a recession happens, it could be bad news for Lloyds. It could result in less mortgage lending — something the UK’s biggest mortgage provider would want to avoid.
The cost-of-living crisis is also weighing on everyday spending and could put pressure both on customer willingness to take out new loans and on their ability to make existing loan repayments. Lloyds voiced its concern regarding a rise in potential loan defaults in its Q1 2022 update, so this risk seems like a real possibility.
However, a positive of higher rates is that it can charge higher rates on its loans. In addition to this, for the first three months of 2022, the bank’s loan book reportedly grew by over £3bn, while mortgages rose just under £2bn. If the bank’s loan volumes are growing, and the rate at which it can charge interest on these loans is also going up, then Lloyds could be in a good place.
Lloyds shares valuation
The shares are currently trading at a modest price-to-earnings (P/E) ratio of 5. This is well under the ‘value’ barometer of 10. It’s also comfortably under the UK average bank P/E ratio of 8.8, signifying the shares might be undervalued.
At 42p each, the stock yields a 4.7% dividend, which would be some nice passive income for my portfolio. In addition to this, City analysts have predicted a steady rise in dividends over the next few years. In 2023 and 2024 the dividends are expected to be 2.6p and 2.8p, respectively. If I bought some shares at today’s price of 42p, that would land me some healthy yields of 6.1% and 6.7%.
The verdict
I think Lloyds shares look cheap and the dividend does entice me. However, with so much uncertainty regarding the UK economy, I’m not convinced about buying the stock just yet. Rising rates could help Lloyds, but could also hinder its performance if loan defaults grow. Only time will tell. For that reason, I won’t be buying the shares today.
