On the surface, the FTSE 100 doesn’t seem to be off to a great 2024 start, with the UK’s flagship index sliding by around 2%. Yet, including the impact of dividends actually places the total shareholder return into the black. And in the last couple of weeks, it seems to be gaining momentum on the back of rising confidence in the financial markets.
Among its constituents lies Lloyds Banking Group (LSE:LLOY), which is by far one of the most popular shares on the London Stock Exchange. Despite this popularity, it’s been a fairly lacklustre investment over the last 12 months, with its valuation dropping by around 20%. Rising interest rates were supposed to be a catalyst for growth, so that may sound odd.
So what’s going on? And is now secretly the perfect time to add this FTSE 100 darling to my investment portfolio?
The headwinds facing Lloyds
Let’s kick things off with interest rates. As the Bank of England (BoE) hiked rates to combat inflation, Lloyds has expanded its net interest margin. In other words, the difference between the interest it charges on loans and interest paid to depositors has grown, pushing the banks’ profits higher.
Obviously, higher earnings are a good thing for shareholders. So why’s the valuation not reflecting that? Unfortunately, higher interest rates are a bit of a double-edged sword. The increased profitability has also come with a sharp increase in loan defaults.
Not every borrower is managing to keep up, causing Lloyds to write off an increasing chunk of its loan book. The BoE could start cutting rates later this year. And this could reduce that risk. But that also means profit margins will be squeezed once again. Overall, higher interest rates for the bank didn’t live up to the hype.
Yet, more recently, there’s another headwind blowing in the form of an investigation by regulators relating to auto loans. Analysts expect the financial institution to be slapped with a hefty multi-billion pound fine on the back of undisclosed commissions to car dealerships. Needless to say, that’s bad news for shareholders.
Potential to surge?
There are a lot of valid concerns surrounding this business that can explain its poor performance as a stock. However, the pessimism may have got a bit out of hand.
Banks typically trade at relatively low multiples. Yet, in the case of Lloyds, it’s now on the verge of being the cheapest in the UK in terms of the price-to-earnings (P/E) ratio. And when factoring in potential growth, shares look like they’re trading at a double-digit discount.
Given the current sentiment surrounding this business, value investors may have to wait a considerable amount of time for Lloyds’ market capitalisation to correct itself upward. But in the meantime, providing that dividends aren’t interrupted, a 6% yield is nothing to scoff at.
So should investors consider buying Lloyds shares this month? I’m not convinced. While the income opportunity looks promising, there are far better stocks within the FTSE 100 to pick from. At least, that’s what I think.
