With its well-known brands, multi-billion-pound profits and huge customer base, banking giant Lloyds (LSE: LLOY) might seem like it has all the ingredients for success. Yet the Lloyds share price has stayed firmly in pennies for over a decade.
Could it end up going much higher – and does that present a buying opportunity for my portfolio?
Pennies and pounds
Just because a share trades for pennies does not automatically make the company cheap. Lloyds is an example of this.
Although the Lloyds share price right now is less than 50p, the company has billions of shares in circulation. So its market capitalisation is £29bn, which makes it sound less cheap than talking about the share price alone.
Still, by some common valuation metrics, the shares do look cheap. For example, it trades on a price-to-earnings ratio of just seven. That seems low for a blue-chip FTSE 100 bank with strong long-term prospects. On top of that, the bank currently offers investors a 5% dividend yield.
What comes next?
But is it cheap in reality? After all, the earnings I used to calculate the ratio above are historical ones.
But the prospective valuation could look less attractive if earnings fall. With the prospect of a recession increasing the number of bad loans on the books of banks including Lloyds, I see that as possible.
In the bank’s first half results, its profit after tax fell 27%. That is a substantial fall – and the economy has been getting worse not better since then.
Those profits still came in £2.9bn, underlining the strength of the bank’s business. But if the economy continues to fare badly, profits could fall further. That might stop the Lloyds share price from breaking out of trading in pennies. Indeed, I think it could fall further, after already losing 8% in the past year.
That helps explain why I sold all my Lloyds shares earlier this year.
Could the Lloyds share price hit £1?
However, banking tends to experience boom periods as well as harder times during recessions. Lloyds has improved its financial resilience since the last financial crisis. That might help it manage the impact of bad loans on its profitability during this recession.
On top of that, rising interest rates could be a boon to bank profits. Higher interest rates might mean Lloyds can make more money from its massive loan book, which at the end of June stood at £457bn.
If the business can play to its strengths and keep bad loans as low as possible, it could see strong earnings in years to come. As sentiment towards banks improves when the end of the recession comes into view, that may help push up the Lloyds share price.
Given its current low valuation, a share price of one pound or higher is possible, in my view. I do not think that would happen for some years though, if at all.
However, my concerns here outweigh my optimism. It is hard for any bank to shield itself fully from an economic downturn. As the UK’s largest mortgage lender, I regard Lloyds as being in the eye of the storm. So although its shares may trade in pounds at some future point, for now I see significant risks and will not be investing.
