Lloyds (LSE:LLOY) shares are among the best-performing stocks on the FTSE 100 this year. But it hasn’t been straightforward with sentiment shifting decisively following the company’s 2023 results.
I remain bullish on Lloyds but, for the first time in a while, appreciate there are clearer examples of undervalued stocks on the FTSE 350 and across the US and European indicies.
What is fair value?
Fair value is the price we think a stock should be worth. For example, the average share price target for the UK banking giant is currently 58.3p, and that represents an 11.3% premium to the current share price.
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Share price targets can be a good way to gain an understanding of what fair value might be without necessarily doing the research ourselves. But we also have to bear in mind that analysts don’t always keep their share price targets up to date.
For example, it may be worth discounting share price targets that were issued more than three months ago. This is definitely the case in fast-moving industries like technology and artificial intelligence (AI) where companies can really surprise analysts.
Interestingly, Lloyds’ average share price target has fallen in recent months and that probably represents the impact of a fine for car loan misconduct. Some analysts had suggested the fine could be up to £2bn. But Lloyds has calmed a few nerves, setting aside £450m.
Coming to my own conclusions
City and Wall Street analysts can be wrong, but I still like to use share price targets as a broad guide. Nonetheless, it’s important that I follow this up with my own research. And I like to do this by looking at the data available to me.
Lloyds is currently trading at 8.2 times forward earnings. That’s higher than it’s been it recent years, but likely reflects the fact that Lloyds will swallow the cost of the aforementioned fine in 2024, thus negatively impacting earnings.
However, looking further forward, Lloyds is trading at 7.1 times expected earnings for 2025 and 6.5 times earnings for 2026. This data often means very little in isolation, but comparisons with UK and European peers show it trading at a slight discount.
Comparing this data with US peers, however, we can see that Lloyds is trading at a huge discount. JP Morgan, for example, is trading at 12.4 times forward earnings, and 12.3 times earnings for 2025. And this is broadly reflective of the premium given to US banks.
There are various conclusions we could come to, but my personal opinion is that British banks, notably Lloyds, don’t deserve this discount to their US peers. Yes, the British economy is growing slower today, but it’s expected to be Europe’s fastest growing major economy over the next 15 years. This is important for cyclical stocks like banks.
Likewise, while economic risks remain today, we appear to be entering something of a golden period for banks with interest rates set to settle in the ‘Goldilocks Zone’ and hedging practices set to boost income throughout the medium term.
I don’t have an exact figure in mind, but I believe fair value’s significantly higher than the share price targets.
