The Lloyds (LSE:LLOY) share price surged 9.8% in December. If that rate of growth is sustained, we’d see Lloyds shares push above the 60p mark at some point in March.
Of course, markets aren’t predictable like that. But it’s certainly the case that we’re seeing renewed interest in Lloyds stock, and fresh momentum.
Moreover, with a price/earnings-to-growth (PEG) ratio of just 0.55, Lloyds could be undervalued by as much as 45%.
Value offering
Analysts are forecasting Lloyds’ earnings per share to increase significantly in the coming years. And this is what leads us to a PEG ratio of 0.55.
The PEG ratio assesses a stock’s valuation by dividing its price/earnings (P/E) ratio by the expected earnings growth rate. A ratio of one is considered fair value. It helps investors gauge whether a stock is undervalued, overvalued, or reasonably priced, relative to its growth prospects.
So a ratio of 0.55 suggests that investors are undervaluing Lloyds, and its future earnings by 45%. That might sound fanciful, but Goldman Sachs has a price target of 80p, and other financial institutions hold similarly strong outlooks.
However, the average share price target for the bank currently sits at 60p. I’d expect to see that rise as more recent updates appear to be upgrades.
Headwinds become tailwinds
When interest rates get too high, it creates both headwinds and tailwinds for banks. These headwinds largely come in the form of rising credit losses, as banks have to put more money aside for loan defaults.
To date, Lloyds appears to have been more insulated from credit losses than its peers. One reasons for this is that Lloyds’s average mortgage customers earns around £75,000 — far above the average salary.
Of course, there’s still risk that credit losses may worsen given the delay related to monetary policy — thousands of mortgage customers are on fixed rates and will soon need to remortgage.
However, falling interest rates will likely reduce the pressure on banks, and notably Lloyds, which doesn’t have an investment arm.
Meanwhile, the eventual fall in loan repayments should be offset by the bank’s hedging strategy.
In banking, a hedging strategy involves using financial instruments or other methods to offset or mitigate risks. When interest rates fall, banks often experience a decrease in the interest income it earns on variable-rate loans.
To counteract this, banks use interest rate derivatives or other hedging instruments to protect against the decline in interest income.
This may involve buying government debt with higher yields. In other words, this allows net interest income to remain elevated as interest rates fall.
In fact, Hargreaves Lansdown research suggests that Lloyds’ gross hedging income will exceed £5bn in 2025 alone. That’s almost double the figure earned in 2022.
My position
And this is why I’ve increased my position in Lloyds going into 2024. The stock could be poised to surge.
So could 60p be realised before the end of March? I have to say there’s no guarantee of that. But it’s certainly possible if we get more data to support the notion that inflation is falling.
And while it seems unlikely that the Bank of England will cut rates at the Monetary Policy Committee’s 1 February meeting, investors will be focusing on clues and narratives.
