It has been an unsettling few months for shareholders in black horse bank Lloyds (LSE: LLOY). Since the start of 2023, Lloyds shares have lost around 10% of their value. Over five years, the shares are down by almost a third.
It is not all bad. With a yield of 5.6%, shareholders are at least receiving chunky dividends.
As a long-term investor, my focus is on what happens five or 10 years down the road.
Could the current share price offer me the chance to snap up a stake in Lloyds now and wait for share price recovery once the economy improves?
Banking outlook
In principle, such an approach could work. Lloyds remains hugely profitable. Indeed, its dividend is covered multiple times by earnings.
The concern I have is what shape Lloyds will be in after a few years of a weak UK economy. As interest rates rise, I expect more borrowers to default on their loans. As the UK’s largest lender, that poses a risk to profits at Lloyds.
However, what will the long-term impact be? On a bearish analysis, it could mean that the stock tumbles even from its current price and stays low. Over the last quarter century, the shares have lost 90% of their value. That is hardly reassuring.
On the other hand, if the economic slowdown is not too damaging, the current price could be a bargain.
Lloyds shares trade on a price-to-earnings ratio of under 6. But the bank has well-known brands and a market-leading position. UK banks have improved their risk management practices since the financial crisis, including improved capital buffers.
Valuing the shares
What does that mean for the potential value offered by Lloyds shares at their current price?
My interest here would be in the potential for long-term capital appreciation. The dividend is attractive and has a lot of room for growth, but Lloyds has past form in cutting the payout. During the pandemic it suspended the dividend due to regulatory requirements. Although it has been restored, it remains at a lower level than it was before.
As to the share price, while I think the bull case has attractions, my concern is about the risks. It may not feel like we are in a banking crisis, but the reality is that the past year has seen several of the biggest overseas bank failures in history. Rising interest rates, high inflation and low economic growth could well drive up mortgage defaults in the UK.
Rather than invest now and hope that Lloyds powers on, I would rather wait to see what happens next in the economy and housing market. If they do badly, I think Lloyds shares could be a value trap even at their current level.
