Throughout 2020, as the coronavirus pandemic ravaged the global economy, I highlighted the Lloyds (LSE: LLOY) share price as one of my favourite recovery investments.
This turned out to be quite literally on the money. Since the end of September 2020, the stock has returned 130%. Over the past year, the shares have returned 41%, as investors have returned to the UK banking sector.
Initially, I believed that the lender’s competitive advantages, namely its size and position in the UK domestic banking market, would help it weather the pandemic and emerge stronger on the other side.
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That is precisely what has happened, although the picture may have been a bit different if it were not for the actions of central banks, which stepped in to stabilise markets in the first half of 2021.
Still, what happened happened. As investors, we have to look to the future, not the past. And the future for the Lloyds share price seems incredibly exciting.
Multiple tailwinds
After more than a decade of ultra-low interest rates, the Bank of England is finally raising them. Rates have already returned to 0.5%, and there is speculation they could hit 1.5% before the end of the year.
Higher interest rates allow lenders like Lloyds to charge customers more to borrow money. They also mean the bank might have to pay more interest to depositors but, broadly speaking, higher rates are generally favourable for the banking sector.
At the same time, the group could benefit from improving consumer sentiment. The latest data shows that consumers are spending more on their credit cards after knuckling down in the pandemic to conserve cash. This could generate additional credit card interest and fees for the company.
On top of these factors, Lloyds may also benefit from increasing demand for its wealth management services. A joint venture with FTSE 100 peer Schroders could help the lender capitalise on the growing demand for wealth management services in the UK and worldwide.
These three tailwinds could all support earnings growth at the bank over the next few years.
Lloyds share price valuation
On the other side of the equation, rising interest rates and the cost of living crisis may lead to more loan losses as consumers struggle to repay their debts. This could hit the bank’s profit margins and capital reserves. It is something I will be keeping an eye on as we advance.
Still, despite this headwind, City analysts expect the lender to report earnings per share of 6.4p for fiscal 2022.
On this basis, the stock is trading at a forward price-to-earnings (P/E) multiple of 8.3. Moreover, the Lloyds share price is trading at a price-to-book (P/B) value of just 0.7. I think this undervalues the business. Most of the group’s profitable and growing peers are trading at P/B multiples of 1 or more.
As such, I do not think it is unreasonable to say that the Lloyds share price could rise as much as 43% from current levels as the group returns to profitable growth.
I would be happy to add the stock to my portfolio today, considering this potential.
