Since 2009, Lloyds Banking Group (LSE:LLOY) has often been described as a penny stock. That certainly makes sense, given the share price has continued to trade below 100p over the last 15 years. And even in 2024, after enjoying a 20% rally, shares are still only trading around 58p.
However, despite appearances, Lloyds isn’t a penny stock. Why? Because its market capitalisation is £36.6bn. That makes it one of the largest companies on the London Stock Exchange.
By comparison, penny stocks are often relatively tiny enterprises with market-caps sitting below £100m. They’re also notoriously volatile – which doesn’t really describe this bank, given the stock has hovered around the 50p mark for over a decade.
Those traits don’t exactly make penny stocks sound all that inviting. Yet, there’s one thing that these firms have in ample supply that Lloyds has been seriously lacking – growth potential. Given time, a successful startup can evolve into a new industry titan, delivering ginormous returns to shareholders who spotted the opportunity early on.
A shifting landscape
As previously highlighted, the Lloyds share price hasn’t exactly been delivering staggering returns of late. Even after taking dividends into consideration, the bank has underperformed the FTSE 100 index by quite a wide margin.
There are a lot of factors at play contributing to this lacklustre display. However, the most significant is undoubtedly the collapse of interest rates. In the wake of the 2008 financial crisis, interest rates were cut to near zero percent to reduce pressure on both business and personal loans.
However, as a consequence, banks like Lloyds have struggled to generate a meaningful profit margin through their lending programmes, especially mortgages. The bank’s tried to make up the difference in volume. But with British home construction targets constantly being missed, there are only so many mortgages the bank can sell.
Now that interest rates have gone up considerably, Lloyd’s net interest margins are far more favourable resulting in the bottom line surging. Sadly, rate cuts are expected to emerge in the near future now that inflation’s almost back under control. A return to near-zero rates is unlikely. But looming rate cuts nonetheless will start to reintroduce pressure on Lloyd’s profit margins once more.
Finding quality penny stocks
Despite the challenges, Lloyds has one trait that almost all penny stocks crave – cash flow. Small businesses are often hit the hardest during economic downturns simply due to a lack of access to financial resources. And that’s why when investing in small-caps, I’m always hunting for the firms that already have an established revenue stream with high levels of cash conversion.
Apart from protecting against market downturns, cash flow grants management teams far more flexibility in capital allocation. And that can be a huge boon when competing against other start-ups that operate with far more financial restrictions.
Obviously, being a cash-generative enterprise isn’t the only trait that defines a winning penny stock. But as a filter, it can immediately eliminate lacklustre businesses from consideration, and helps investors avoid falling into traps.
As for Lloyds, its shares continue to be at the mercy of interest rates, which are beyond management’s control. Personally, I prefer investing in businesses that are in more control of their own destiny. Therefore, it’s not a stock I’m tempted to buy right now.
This post was originally published on Motley Fool
