After falling to a 52-week low of around 48p in mid-August, the Lloyds (LSE: LLOY) share price has rallied hard during the past few months.
It’s currently changing hands for just under 62p, after rising an impressive 24% in only three months, outperforming the FTSE 100 by 18% over the same period.
Investors have been rushing to buy shares in the UK’s biggest mortgage lender following the publication of Boris Johnson’s Brexit deal. All UK domestic stocks surged after the deal was approved, and they’ve since continued to trend higher as investors believe there may be a solution to Brexit on the horizon.
That said, I think it’s unwise to buy stocks based on political projections. Instead, I’d rather invest in solid fundamentals, and Lloyds has some of the most attractive examples in the European banking sector.
Return to growth
Lloyds’ third-quarter results were some of the worst in the bank’s recent history. The group reported a 97% decline in pre-tax income for the three months to September. A £1.8bn charge for mis-selling PPI, coupled with a 31% rise in impairment charges to £371m, consumed profits.
However while bad, these results were not particularly worrying. The bank’s new CFO informed investors that the rising impairment cost was due to one large corporate customer, while the deadline for claims drove the additional PPI charge. Now this has passed, Lloyds has hopefully put the ghost of PPI to bed once and for all.
This suggests to me that the bank is set for a healthy 2020, if current trends continue. With this being the case, I think the stock looks undervalued at current levels. It’s currently changing hands at a forward P/E multiple of 8.3, around half of its five-year average.
A P/E of 8.3 suggests to me the market is assuming the worst-case scenario, an economic downturn, will hit the bank next year. While it’s difficult to tell at this stage if the UK economy will collapse into recession next year, I think there’s around a 50/50 chance of this happening.
The good news is, because the market has already priced the stock for the worst-case scenario, if it plays out, the downside for investors could be minimal.
On the other hand, if the UK economy returns to growth next year and Brexit is sorted out quickly, shares in Lloyds could rebound to their five-year average valuation, which suggests an upside of around 50% from current levels.
The bottom line
So that’s why I think the Lloyds share price is still under value after its recent performance. At the current price, there’s much more upside potential for investors than downside risk.
In the meantime, the stock offers a dividend yield of 5.5%, which is set to rise to 5.7% next year.
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Rupert Hargreaves owns no share mentioned. 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.