Despite their popularity, Lloyds Banking Group (LSE:LLOY) shares have been a pretty abysmal investment. And not just in recent years. Zooming out, the lending institution once traded at an impressive share price close to 500p in the late 90s.
Compared to today’s valuation of 42p, that’s a 91.6% drop in just over 20 years. And while dividends have helped to offset this downward trend, long-term investors are likely still in the red.
Since February this year, Lloyds shares have continued to head in the wrong direction, dropping by double digits. It seems investors are giving up hope. However, recent changes in the macroeconomic environment might have just offered the bank a stepping stone to get back on track.
In fact, management just completed a £2bn share buyback plan. And dividends look like they’re on their way to being hiked once again for the third year in a row..
What’s going on? And is 2023 finally the year Lloyds justifies its popularity?
Banks love interest rates
It should be no surprise that when interest rates are high, lending institutions can boost their profits. After more than a decade of near-zero percent rates, it’s impressive Lloyds made any money at all. But thanks to inflation, that’s no longer the case.
The company has already surpassed internal lending margin expectations. And as new loans are issued at higher rates, this boost in profitability is likely to continue, even after the Bank of England finishes its fight against inflation.
Subsequently, earnings are on the rise by double digits. And with more excess cash flow at hand, management has been busy increasing payouts. At the end of 2022, the dividend per share stood at 2.4p versus 1.12p in 2019. And following its latest results, the interim dividends jumped by 15% from 0.8p to 0.92p.
Higher earnings, cash flow, and dividends are fantastic news for shareholders. So why is the stock seemingly not reacting to this progress?
Interest rates hate consumers
As encouraging as the improving financials are, investors may be justified in being pessimistic. While interest rates help boost banks’ profit margins, it comes at the expense of consumers.
The UK is already narrowly avoiding a recession. And as interest rate hikes continue to pressure household budgets, consumers are already starting to clamp down on unnecessary spending. This economic environment makes growth far more challenging, reducing demand for new loans and increasing the odds of defaulting on existing ones.
In fact, Lloyds has already started to write off a small chunk of its loan book in the face of rising bankruptcies among small businesses. In other words, the gravy train may not last.
As things stand, there are a lot of unknown factors surrounding Lloyds shares. Profitability is improving, but this may only be a temporary boost before things turn to custard, especially if the UK falls into a recession after all.
As I see it, an investment into Lloyds is a bet on the British economy. And while I’m optimistic for the long term, the short term is a giant question mark that other UK stocks don’t seem to have over their heads.
Therefore, I believe there are better opportunities for investors elsewhere.
