Lloyds (LSE:LLOY) shares have extended gains in recent weeks. But at 52p, this stock still looks expensive to me. In fact, it trades with a price-to-earnings (P/E) ratio of just seven — that’s around half the FTSE 100 long-term average.
So, what’s behind this low valuation? And can Lloyds surge to 75p in 2023?
Valuation
When we look at several near-term valuations, such as the P/E ratio, we can see that Lloyds trades at lower multiples than its peers. The sector average is around 10, so 30% higher than the UK’s largest mortgage lender.
A spread of discounted cash flow (DCF) models shared online — using analysts’ forecasts for cash flow — also suggest the stock is substantially undervalued. One calculation reaches a fair value of £1.21, around 60% ahead of the current price.
So, these metrics clearly suggest there’s room for share price growth.
Sentiment
Sentiment is always a considerable factor influencing a share’s price. And with Lloyds, the market has been steadfastly bearish towards it for some time.
So, why have investors shied away from Lloyds?
Well, banks tend to reflect the health of the economy. And, the current stripped down version of Lloyds is very UK-focused. In fact, around 60%-70% of its revenue comes from UK mortgages.
Naturally, especially since the Brexit vote, sentiment about the health of the British economy has been fairly negative. Some data suggests the UK economy is 5% smaller today as a result of the vote.
However, after the recent rally, I’m starting to wonder if this sentiment is beginning to change. This appears to be because of the impact of higher interest rates.
Could a low growth, higher interest rate environment have a lasting impact on investor sentiment? It’s hard to tell. I’m keeping a close eye on the results due on 22 February.
If the bank has a positive take on the economic environment in the year ahead, then the share price may see some upward pressure.
Results
In Q3, impairment charges soared to £668m from a release of £119m a year before as bad debt concerns increased.
But, we’re also seeing that higher interest rates are acting as a massive tailwind, propelling revenues forward.
So, what will Q4 performance look like? That’s the big question.
This is essentially because higher interest rates are a double-edged sword. Net interest margins have soared to around 2.9%-3%, but the risk of customer defaults rises as repayments grow.
Lloyds is also earning more from deposits with the Bank of England — as much as £200m for every 25 basis point hike.
Can Lloyds continue to surge?
Will we see 75p shares this year? It’s certainly possible. A 33% rise in the share price would bring its valuation in line with peers and it would still trade beneath its fair value, according to several DCF calculations.
Investor sentiment is key here for the reasons mentioned above. I definitely think we will see further upward movement in the share price in 2023, it just might not be as much as I’d hope for. Nevertheless, I will continue to increase my holding in the bank.
