Up 33% in 3 months but Lloyds shares still look undervalued to me

Lloyds shares are finally in demand after a tough few years. While they’re more expensive than they were, Harvey Jones still reckons they’re still good value.

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I’ve enjoyed the rally in Lloyds (LSE: LLOY) shares having added them to my Self-Invested Personal Pension (SIPP) last year.

The Lloyds share price had floundered for years, along with the other big FTSE 100 banks, but it looked cheap and I felt its fortunes had to change at some point.

Top UK banking stock

I took the plunge and bought Lloyd shares for several reasons. First, I’d just transferred three legacy workplace pensions into my SIPP and wanted to invest the lot in direct equities rather than boring old insurance company funds.

Lloyds was high on my shopping list because its domestic focus made it a core UK portfolio holding. It was also dirt cheap, trading at around five or six times earnings, while the forecast yield was racing past 5%.

I also felt I would benefit when interest rates fell, mortgage rates retreated and the economy started moving again. The resulting feelgood factor would outweigh the inevitable squeeze on margins. Plus that dividend income would look even more attractive, once bond yields and savings rates went into decline.

That scenario hasn’t quite panned out yet, as interest rates stay higher for longer than originally hoped. Despite that, the Lloyds share price has jumped from 41.4p to 55.20p over the last three months, and is up 19.07% over 12 months. Add in the dividend and investors will be sitting on a total 12-month return of around 25%. Which isn’t too shabby.

The big question is whether Lloyds can continue to climb. I think it can, depending on events. First, it still looks decent value, trading at 9.55 times forward earnings. A price-to-book ratio of 0.7 shows the market price is still a fraction of the bank’s underlying net worth.

Value opportunity

Better still, Lloyds may be turning into the dividend aristocrat. Investors who buy today can anticipate a yield of 5.36% in 2024, rising to 5.91% in 2025. Yes, they can get 5% on easy access, but that’s likely to slide in the months ahead, rather than rise.

Naturally, shares are riskier than cash, and Lloyds faces plenty of challenges. It has set aside £450m for possible consumer claims against its motor finance business. Nobody knows how much that’s going to cost the big banks. Let’s just hope it’s not another PPI.

Also, the cost-of-living crisis isn’t over yet. People feel poorer and house prices still look dauntingly expensive to first-time buyers, hitting mortgage business.

Then there’s those margins. They fell from 3.22% to 2.95% in Q1, while underlying net interest income tumbled 10% to £3.2bn. Quarterly profit before tax fell from £2.2bn to £1.63bn year-on-year. Impairment charges did fall from £243m to £57m, which is good news, but that only went a small way to offsetting the damage.

I’m still optimistic though. As inflation falls, with a big drop expected when April’s figure is published next week, I think Lloyds shares have room to grow. If I didn’t already hold them, I’d be happy to buy more today.

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.

Harvey Jones has positions in Lloyds Banking Group Plc. 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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