Lloyds (LSE:LLOY) shares are among my biggest holdings. The stock has seen some downward pressure in recent months, but not as much as its peers.
The bank is down around 12% from its highs earlier in the year — Silicon Valley Bank (SVB) is largely to blame. That’s not great for my holding, but there’s definitely an upside. I believe the SVB fiasco and the resulting panic that impacted most banks has created an excellent buying opportunity.
But I’m not just buying more because I believe the stock is at a great price. It’s because I think it’s a great company.
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Let’s explore why.
Valuation
The first place to start is the valuation. Lloyds shares trade at just 6.7 times earnings. That means its one of the cheapest companies, using the price-to-earnings metric, on the FTSE 100. In fact, Lloyds’ P/E ratio is approximately half that of the index.
We can also look at the discounted cash flow metric. This is a method that estimates the value of an investment using its expected future cash flows and subtracting a discount rate which reflects the time value of money.
I didn’t do my own DCF model this time, but looking at other analysts’ models, I can see that Lloyds could be undervalued by as much as 60%. That’s huge — remember legendary investor Warren Buffett tends to look for stocks that are undervalued by 30%, or more.
So according to these two metrics alone, Lloyds looks cheap right now. We can also couple this with the juicy 4.8% dividend yield. At the current price, and using a forecast for 2024, the dividend yield could reach as high as 6%.
A bright future
Interest rates are high right now. And after recent UK inflation data, there’s a suggestion that the Bank of England will need to raise rates in the near term. But hopefully, we can still expect to see central bank rates fall before the end of the year.
Higher rates mean higher net interest margins and greater interest income on assets held with the central bank. But it also means less business and higher impairment charges as debt turns bad.
This is a real concern now, especially in the UK. Lloyds is heavily focused on the UK mortgage market, and amid a cost-of-living crisis, many people are struggling with their elevated repayments.
Ideally, banks should perform best with central bank rates around 2-3%. At this level, net interest margins are elevated versus where they have been over much of the last decade, but there should be less impairment charges on bad debt.
Thankfully, this is where central bank rates are heading, and are expected to stay, in the medium term. So I’m actually buying more Lloyds shares now for the next 3-6 years, during which I think banks will really prosper.
