Lloyds (LSE: LLOY) has been a strong performer in the FTSE 100 over the past year, with the shares surging by an impressive 33%. But despite this recent rally, many suggest that the firm might still have significant potential. So let’s consider whether the Lloyds share price could be just getting started.
The valuation
According to a discounted cash flow (DCF), the shares are trading at a whopping 53.3% below estimates of fair value. This implies that the current share price of around 56p could potentially climb to over 85p, if it were to reach this estimated fair value.
Of course, valuation estimates should always be taken with a grain of salt. These are based on various assumptions and projections. However, such a large discrepancy between the current price and estimated value certainly warrants attention.
The bank’s fundamentals paint a picture of a company in robust health. The business boasts a price-to-earnings (P/E) ratio of just 7.8 times. This is considerably lower than many of its banking peers and the broader market average.
Furthermore, the firm has demonstrated strong earnings growth, with profits increasing by 17.4% over the past year. Looking ahead, analysts forecast annual earnings to grow at 5.28% for the next five years. While this isn’t exactly explosive growth, this consistent expansion could provide a solid foundation for the future.
The shares offer a generous 5.14% dividend yield. This is well covered by earnings, with a payout ratio of 41%. I like what I see here, suggesting that not only is the dividend sustainable, but there’s also room for potential increases.
Moreover, management’s been actively returning capital to shareholders through share buybacks. The company has bought back over 41m shares in the last week alone.
Risks
While the investment case looks fairly compelling, I’d suggest there are a number of risks to consider. The bank faces an uncertain economic environment, with concerns about inflation, interest rates, and the overall health of the economy. As a bank heavily focused on the UK market, Lloyds is particularly sensitive to domestic economic conditions.
One of the metrics I look at closely for banks is the allowance for bad loans, which reflects the level of exposure if customers are unable to keep up with payments. At an allowance of 45%, if the economy takes a negative turn, and loans considered higher risk are defaulted on, the company could be more affected than competitors with a higher allowance.
Additionally, the banking sector’s facing increased competition from fintech disruptors and changing consumer behaviours. Management will need to continue investing in digital transformation to maintain its competitive edge.
I’ll be buying
The Lloyds share price has enjoyed a strong year, but I think there are compelling reasons to believe it might just be getting started. Potentially trading at a significant discount to estimated fair value, boasting solid fundamentals, and an attractive dividend yield, it ticks a lot of my boxes.
Sure, there might be some bumps along the way after such a healthy rally. However, I’m willing to weather some short-term fluctuations if growth can continue over the coming decades.
I’ll be buying shares at the next opportunity.
This post was originally published on Motley Fool
