If I bought Lloyds shares now, what could my return be in a year’s time?

Jon Smith tries to understand what benefit Lloyds shares could get from the higher interest rate environment, as well as the potential risks.

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The share price for Lloyds Banking Group (LSE:LLOY) is very close to hitting fresh 52-week highs at 54p. Lloyds shares have been on a tear, up 26% over the past three months. It might be flat over the past year, but there’s clear momentum being built on, especially thus far in 2023.

So if I invested now, could I reap the benefits going forward?

Enjoying monetary policy actions

To understand what my return could be, I need to look closely at what has been driving the run higher and assess if this could continue.

One clear benefit has been the situation with interest rates here in the UK. It has been moving higher over the past year, allowing Lloyds to benefit from higher net interest income. Yet if the central bank was to raise rates too high later this year, it would risk pushing the UK into a deeper recession.

Over the past month, the Bank of England has been hinting that it’s now close to the peak rate. This is good news for Lloyds. Given that it serves predominantly a retail client base, the signal that rates are unlikely to head much higher is good for mortgage rates and other loan products.

In a way, it’s a balancing act that (so far) is working in Lloyds favour. High rates allow it to earn more money, but the rate isn’t high enough to materially damage the retail client base.

A gauge of potential gains

From when the central bank started the rate hike cycle last April, Lloyds shares are up 25%. The interesting point to note is that there’s a lag between rates being lifted and the bank enjoying the benefit of a higher net interest margin.

For example, the 2022 year-to-date margin at the end of Q3 was 2.84%. I’d expect this to rise close to 3% for the Q4 figures. With the base rate now at 4%, I’d expect it’ll take until the end of this year before Lloyds margin reaches anywhere close to this.

Why I flag this up is that the profitability of the bank should keep increasing, even after interest rates stagnate. Therefore, I think the potential upside for the share price is around the 25% mark, reflecting the lagged benefits of higher earnings over the next year.

Aware of the risks

I’m conscious that I could also have a negative return if I buy the stock now. A large risk is that I’ve misinterpreted the economic data and that the UK could really struggle with interest rates as high as they are. Loan defaults, lower card spending and other factors could lower revenue for the bank.

Another potential issue is the continued closure of branches. Some 18 units are due to be closed in the spring. Even though digital banking is the future, closing locations does severely reduce older clients’ banking options and can also have a reputational impact.

I feel the best-case scenario could be a price up 25% from current levels. Yet I’m also aware that the fragility of the economy could see investors flee from the stock later this year. On balance, I do feel I could earn some form of positive return and so am considering adding the stock to my portfolio.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Jon Smith has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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