Lloyds (LSE:LLOY) shares fell 10% in the first half of January. This fall came despite the bank not releasing any earnings data or comments during the period. The slump was entirely led by macro data.
Unfortunately, after some hot jobs and inflation data from around the world, central banks, including the Bank of England, won’t be in a position to cut interest rates as soon as many of us hoped.
So, are we looking at a golden opportunity to buy Lloyds shares? I think so.
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Find value
It’s always important to be data-driven when making investment decisions. And that means avoiding emotive decisions and letting metrics and research inform my decision making.
There are several ways we can establish the fair value of a company. We can use metrics like the price-to-earnings ratio, the price-to-earnings growth (PEG) ratio, and discounted cash flow model.
In an ideal world, we bring all these metrics together and establish how the company in question is doing versus its peer group.
We also need to consider how profitable a company is, and it’s forecast for growth.
Lloyds’s valuation
Despite a recent, and not very positive, revision to the earnings forecast, Lloyds still looks like great value.
The company is expected to experience earnings per share (EPS) growth of 7.6% annually over the coming three–five years. And while that might be a little lighter than industry peers, it still bodes well for the valuation.
In turn, we can see that Lloyds is currently trading at 4.6 times earnings for the past 12 months and 6.1 times forward earnings.
That makes it one of the cheapest banks globally. On a forward earnings basis, it is 43.3% cheaper than its peers.
In turn, the earnings growth rate of the next three–five years leads us to a PEG ratio of 0.75. This infers that Lloyds is significantly undervalued.
Risk
One reason Lloyds looks so cheap is risk. It’s a UK-focused bank and is heavily geared towards the mortgage market. It also doesn’t have an investment arm like many of its peers.
However, this does mean that Lloyds is more exposed to negative pressures in the housing market than almost all of its peers. And this means the risk of sizeable impairment charges relating to mortgage defaults.
To date, that’s not been much of an issue. In fact, Lloyds’s impairment charges came in much lighter than expected in the last quarter. And one reason for this could be that the average income of a Lloyds mortgage customer is £75,000 — far above average.
The bottom line
With Lloyds shares falling 10.4% in the five days to 17 January, it does seem like something of an overreaction from the market.
Personally, I see Lloyds as a staple of my portfolio. Its fundamentals are very strong, but it may not actualise its potential until we see some downward movement from the Bank of England.
