Should I buy cheap Lloyds shares as the FTSE 100 rallies?

The FTSE 100 is up by more than 12% since January 2024 as inflation falls to 2%, but is Lloyds still to cheap even after this market rally?

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The FTSE 100 is on an impressive roll so far this year. While Britain’s economic landscape is far from repaired, progress in the battle against inflation has bolstered investor confidence. As such, the UK’s flagship index is up by double-digits since mid-January, and Lloyds (LSE:LLOY) shares appear to be tagging along for the ride.

Over the same period, the banking giant has seen its valuation climb by almost a third, pushing the share price back above 50p for the first time in over a year. Yet, even with this impressive rally, the stock is still trading firmly below pre-pandemic levels. And that’s despite delivering massively improved earnings. So, are these cheap shares worth buying today?

Capitalising on interest rates

On the profit side of the equation, Lloyds is smashing it. The FTSE 100 bank set a new record for pre-tax profits in 2023 which surged by 57% year-on-year reaching £7.5bn. There are a lot of moving parts behind this boosted performance. But it’s no secret that higher interest rates have been a boon. As such, management hiked dividends from 2.4p to 2.76p and launched a new £2bn share buyback scheme.

A looming concern is the threat of interest rate cuts from the Bank of England. After all, now that inflation is almost in line with the central bank’s target, the gravy train may soon come to an end. Yet this concern may be unfounded.

Higher interest rates are great for bank profits so long as borrowers can keep making payments. And there are some trouble economic trends that suggest this is getting quite difficult. For example, private business bankruptcies in the UK have skyrocketed, and the number of late payments on mortgages is also climbing.

Left unchecked, these trends could prove to be a massive problem for Lloyds as its loan book transforms from an asset into a liability. That’s why interest rate cuts may prove advantageous. The bank’s net interest margin may suffer. But loan affordability will improve, reducing the risk of default from existing customers while also attracting new ones.

With that in mind, these shares certainly sound interesting, especially at a price-to-earnings ratio of just 7.4. So, what’s the catch?

What’s the problem?

Like most banking institutions, Lloyds has had its fair share of scandals. And the company may be in the middle of another one today. Regulators are investigating the group for foul play in the car financing space, which Lloyds has already set aside £450m to settle claims.

However, regulatory probes aren’t the only thing holding Lloyds shares back. The business generates almost all of its revenue from within the UK. As such, it’s highly sensitive to Britain’s economy. In the short term, this is proving advantageous. But in the long run, it’s a bit of a headwind.

Even before Covid-19 and inflation came along, Britain has struggled to eke out meaningful growth. And it’s a trend that may be set to continue even after inflation leaves the headlines. At least that’s what KPMG’s forecasts currently suggest, with a whopping 1% growth estimate by the end of this decade.

Therefore, this FTSE 100 stock may be priced cheaply for good reason. And given there are other more promising enterprises in the financial space, it’s not a stock I’m interested in buying 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.

Zaven Boyrazian 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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