Lloyds (LSE:LLOY) shares are among the most traded on the FTSE 100. It’s one of Britain’s big three banks, but despite it being popular with smaller investors like me, its share price has struggled for some time.
Is that fair? After all, the company is far more robust than it used to be. Antonio Horta-Osorio was brought in after the financial crisis to reduce the bank’s exposure to risk. He’s since been knighted for his time in the head office and it looks like a much lower-risk investment.
The market is pretty depressed right now, but I think Lloyds can thrive when the market recovers. Here’s why.
Low risk, low valuation
UK mortgages represented 61% of Lloyds’ total gross lending at 2021 year-end. And two-thirds of the bank’s income comes from the UK. While it’s trying to develop its investment arm, I see the portfolio as fairly low risk.
I appreciate housing prices can go down, but they fluctuate less than prices of stocks and shares. House prices might well go down in the near term, as growth slows and interest rates rise. But there are no signs of a crash. And in the long run, housing demand is likely to stay ahead of supply. I’m pretty confident that this is a good business to be in.
Lloyds is also moving into the rental market, buying a reported 50,000 homes in the UK over the next decade. I also don’t see this as a high-risk strategy, but one that might yield some pretty solid returns.
But this lack of exposure to high-growth markets and segments is also reflected in its relatively cheap valuation. The stock has a price-to-earnings ratio of just 5.8.
Margins
Rates are important for a bank like Lloyds. And interest rates have been depressed for nearly a decade now. This is one of the reasons bank earnings have been lower over the past decade.
But interest rates have been rising in 2022, and they are due to rise further. Higher interest rates generally help Lloyds’ net interest margin, as rates on its assets typically rise in line with rate hikes. The impact of rate rises on the entirety of its portfolio will take time to show, but the bank already seems to be benefiting.
Higher rates even mean that Lloyds will earn more interest on the money it leaves with the Bank of England.
Interest rates may stay higher even when the economy recovers.
Would I buy this stock?
I’ve already bought Lloyds shares for my portfolio, but I’d buy more at today’s price. Credit Suisse recently made Lloyds its “top pick” in the UK banking sector and gave it a target price of 71p.
I can certainly see the share price rising sharply from the 43p it trades at today.
One of the biggest issues, in my opinion, is market sentiment. Lloyds is something of an unloved share, and this is reflected in its valuation. But there’s also a lot of negativity surrounding the UK economy post-Brexit right now.
Yet over time, sentiment should improve and the market should recover. For me, Lloyds is a no-brainer buy right now. I’d buy more today as I see it as a bigger winner when the market recovers.
