Lloyds (LSE: LLOY) shares are not playing ball.
Investors have been keen on the banking giant for over a decade because its valuation looks cheap.
However, near 45p, the stock is down around 24% over the past five years and 85% over 10 years.
The trading figures for the past five years show that growth in the business has not arrived as hoped.
At the end of 2018, the company’s net profit was around £4.4bn, and the expectation for 2023 is around £5.1bn. That’s progress, but analysts have pencilled in a decline for 2024 to about £4.5bn.
If that estimate comes true, Lloyds will have been on a round trip with profits over six years set to end up close to where they started.
A shrinking valuation
It looks like the market has been compressing Lloyds’ valuation over the past few years because of evaporating growth hopes.
However, a low valuation doesn’t guarantee a floor for the share price. Lloyds’ operations are cyclical. That means a decline often follows a period of rising profits as the business dives into another low.
My fear is that next year’s trend of declining profits could continue into later periods. After all cycles tend to move in that way. Meanwhile, the Lloyds share price has been below 30p before in 2009, 2011 and 2020. It could easily go there again.
So a keen valuation make sense. It could be the market’s way of adjusting for the potential of lower profits ahead.
Meanwhile, banks like higher interest rates because it’s easier to profit from the ‘spread’.
In other words, their margins can increase because of the larger difference (or spread) between the costs of borrowing and lending money. One way that Lloyds borrows is by using money people put in savings accounts. Then the company lends for things like mortgages and other loans.
Banks tend to pay lower rates when we save money and charge higher rates when we borrow. That’s the spread in action.
So why are the company’s profits forecast to be lower in 2024 when interest rates have been rising for the past two years? One reason could be the increased expectation of default. If the interest on loans and mortgages gets too high, many people will not be able to pay.
Another reason for lower profits ahead could be that interest rates may have passed their peak. Inflation has been dropping and interest rates will likely follow. Indeed, the banks may have already seen their best profitability in this cycle.
Volatility assured ahead
So there’s plenty of scope for the Lloyds share price to drop below 30p again in 2024, driven by falling profits. But if it does, I’d turn bullish on the stock because the business will likely be set up for a cyclical rebound.
It’s not all bad news. There’s no immediate sign of a dividend cut. At this level the projected yield for the current year is around 7%.
In one scenario, an improving economy could drive business performance in the coming months/years.
In the near term, anything could happen with Lloyds’ share price and the cyclicality in the business adds up to a hidden danger for investors.
Volatility ahead seems assured. Therefore, the company’s stock does not have the makings of a quality long-term hold for me.
