The past year has seen shares in banking giant Lloyds (LSE: LLOY) lose 8% of their value. But since an October low, the Lloyds share price has moved up by a quarter. As I do not own the stock, I have missed out on that rally.
I have however, been thinking about what might come next for the business. Here are three possible scenarios I am using to consider whether or not to invest in Lloyds again.
1. Improving performance
I see the upside scenario for Lloyds as one where an economic recovery in the short term helps the bank play to its strengths.
As a UK-focussed bank, Lloyds is more sensitive to shifts in its home economy than some more internationally-focussed rivals. If the UK pulls out of recession and rebounds quickly, that could be good news for Lloyds.
As its 2021 pre-tax profits of £5.8bn demonstrate, running a retail and commercial bank with a large customer base can be very lucrative.
Currently, the bank trades on a price-to-earnings ratio of less than six based on those 2021 earnings, the last full-year figures we have at the moment.
If the economy picks up fast, Lloyds might see earnings hit new highs. On that basis, the current Lloyds share price could turn out to be a real long-term bargain for my portfolio.
2. Sideways drift
An alternative possible scenario is that we enter a period of several years during which the economy stagnates, neither recovering nor getting worse.
That also could be okay for Lloyds, depending on what happens to loan default rates. If the number of lenders falling into arrears does not jump, the Lloyds business may tick over quite well.
I think the current Lloyds share price reflects investor concerns that profits could fall in a recession. If that does not happen, the current price could be a bargain. Indeed, I could imagine it moving up if the City becomes more confident in the resilience of the business.
Normally a recession can be quite tough for the banking sector. That can hurt valuations. But for now at least, Lloyds continues to emphasise that it is largely business as usual and default rates are not at an uncomfortably elevated level. However, if the economy gets worse, I fear that could change fast.
3. Deep wounds
The above scenarios do not seem too bad to me as an investor. Indeed, they could play to Lloyds’ strengths as a well-established bank with a large customer base. So what might be behind the firm’s low share price?
I think it is concern about a scenario in which there is a long, deep recession. If that leads more borrowers to default, profits could shrink dramatically at banks including Lloyds. On top of that, a housing market downturn could make banking less profitable in years to come.
For now, it is hard to tell how rough the coming years will be economically.
However, Lloyds is in a much more robust financial position today than it was during the financial crisis 15 years ago. Still, a bad few years for the economy could see revenues fall and profits tumble. That risk is why I am not buying into Lloyds at the moment.
