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Why I think FTSE 100-member Lloyds’ share price could be worth 100p

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While the FTSE 100 may have enjoyed a decade-long bull market, a number of its members appear to offer excellent value for money. One example is Lloyds (LSE: LLOY), with the bank’s shares currently trading on a price-to-earnings (P/E) ratio of just 7.5.

This suggests they could offer a wide margin of safety at a time when the prospects for the UK banking sector are highly uncertain.

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Of course, other stocks also experiencing challenging futures lack value for money at present. One such company released a disappointing update on Tuesday, and may therefore be worth avoiding.

Weak sentiment

The stock in question is manufacturer of optical components and systems Gooch & Housego (LSE: GHH). Its interim results showed a fall in adjusted pre-tax profit of 22.8%, with a challenging industrial laser market the key cause for the decline. It’s been impacted by a cyclical downturn, as well as the impact of the US/China trade dispute.

As a result, the company has reduced its guidance for the full year, which prompted a 24% fall in its share price following the release of its results. Although the company remains optimistic about prospects for the industrial laser sector over the long term, and is seeking to invest in R&D alongside greater diversification, weak investor sentiment could push the Gooch & Housego share price even lower in the short run.

Uncertain outlook

Although sentiment towards the Lloyds share price has been weak at times in the last few years, the company has been able to deliver improving operational and financial performances. Key to this has been its ability to reduce costs at a faster pace than many of its industry peers, now having a highly competitive cost/income ratio.

In tandem with cost reductions, Lloyds has also been able to invest in its long-term growth potential. It appears to be aligned with changing customer tastes, with investment in its digital offering likely to remain high.

While there are risks ahead for the business from a weak UK economy, its current valuation suggests the stock has a wide margin of safety. As mentioned, it trades on a P/E ratio of 7.5. Assuming the stock will trade on a still-highly-appealing rating of 13 over the long run, it could be worth over 100p. This would represent a potential capital gain of around 75% from its current price level.

Of course, political and economic risks could hold back investor sentiment in the near term. But with the prospect of rising interest rates, the end of PPI claims, and a dividend yield in excess of 6%, Lloyds appears to have an enticing risk/reward ratio for long-term investors.

Therefore, even though further pain could be ahead in the short run from a weaker operating environment, its long-term growth capacity appears to be high.

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Peter Stephens owns shares of Lloyds Banking Group. The Motley Fool UK has recommended Gooch & Housego and 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.

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