With the Lloyds (LSE: LLOY) share price lagging the FTSE 100 by around 4% since the start of 2018, it has been a disappointing year thus far for the bank’s investors.
Clearly, the prospects for the business appear to be relatively uncertain. However, a recent announcement suggested that it is yet to see difficulties resulting from Brexit and the general uncertainty for the UK economy, while its strategy implementation seems to be moving along as planned.
As such, could there be an improvement in its performance versus the FTSE 100? Or does the wider index offer scope for further outperformance in the remainder of the year?
The prospects for the UK economy remain unclear. The Bank of England recently downgraded forecasts for the GDP growth rate, and this was probably a key reason why it chose to maintain interest rates at its latest meeting.
Neither of these developments is particularly positive for Lloyds. The bank is focused on the UK economy, and with consumer confidence being at a low ebb and business confidence also potentially volatile ahead of Brexit, it could mean that demand for its services comes under a degree of pressure. And with interest rate rises now likely to be somewhat limited over the near term, the prospects of improved trading conditions seem to be moving further away.
Margin of safety
However, the UK economy’s growth rate and the expected path of interest rates over the next few years suggest that Lloyds may be worthy of a higher valuation. Interest rates are due to reach 2% by 2020 and while this is not a ‘normal’ level, it suggests that trading conditions may improve over the medium term. Furthermore, with the UK economy holding up better than many investors and politicians had anticipated prior to the EU referendum, it would be unsurprising for this trend to continue.
As a result, the company’s valuation could offer a wide margin of safety. It has a price-to-earnings (P/E) ratio of 10.5 at the present time, which is relatively low. And with a dividend yield of 5.2% from a shareholder payout that is set to be covered 2.2 times by profit this year, it could indicate investment appeal versus the FTSE 100’s 3.9% yield.
Clearly, investor sentiment towards Lloyds is weak at the present time. Given the outlook for the UK economy, this could remain the case in the near term. But with an interest rate rise planned for later in the year and the company continuing to implement a relatively aggressive growth strategy, it seems to be in a strong position for the long term.
As such, even though it has underperformed the wider market so far in 2018, its potential to beat the FTSE 100 seems to be high. Therefore, it could be worth buying for the long term.
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Peter Stephens owns shares of Lloyds Banking Group. The Motley Fool UK has recommended Lloyds Banking Group. 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.