Lloyds Banking Group (LSE:LLOY) shares have soared 31% over the past year on hopes of improving economic conditions. Markets are hoping profits will rebound strongly as the Bank of England (BoE) begins cutting interest rates, in the process stimulating economic activity.
The FTSE 100 bank‘s seen earnings reverse in three of the past five years. And although another reversal’s tipped for 2024, the bank’s bottom line is backed by City analysts to bounce back sharply thereafter.
If correct, Lloyds’ share price could add to the significant gains it’s already enjoyed of late. But of course it’s not unusual for earnings to fall short of analysts’ forecasts.
So could the Black Horse Bank deliver (or even beat) current City predictions? And should I buy Lloyds shares for my portfolio today?
The bull case
More than those of most other stocks, banks’ profits are massively dependent on broader economic conditions.
When times are good, lending activity rises, and the number of credit impairments becomes a lesser problem. With interest rates tipped to steadily fall, analysts expect the UK’s economy to pick up steam and drive earnings at Britain’s banks.
Encouragingly for Lloyds and its investors, economists are taking a positive view on British GDP. The IMF, for instance, is now forecasting growth of 2.5% this year and 2.2% in 2025.
Lloyds will also benefit from a boost to housing demand that lower interest rates will surely provide. This is critical given the bank’s position as the UK’s biggest mortgage provider (more than two-thirds of all its loans and advances are home loans).
Mortgage activity’s already picking up in fact, which is highly encouraging. And so total mortgages on the firm’s books edged higher again in the third quarter, up 1% to £310m.
The bear case
But while economic growth might boost lending, the benefit of higher loan volumes may be more than offset by a sharp fall in margins.
Banks’ net interest margins (NIMs) are already falling as interest rates drop and market competition intensifies. Lloyds’ own NIM narrowed by 21 basis points between January and September, to 2.94%, and the scale of decline could balloon if the BoE (as expected) periodically slashed rates.
Lloyds’ earnings forecasts are also in danger as economic uncertainty drags on. Britain’s economy faces significant growth challenges including low productivity, labour shortages and high public debt, which could hit loan growth and result in high levels of bad loans.
The economy also faces significant trade-related threats that may have worsened following Donald Trump’s election victory. The National Institute of Economic and Social Research (NIESR) says new US tariffs alone could damage UK growth by 0.7% and 0.5% in 2025 and 2026 respectively.
The verdict
Given these widescale challenges, I believe Lloyds may struggle to achieve the strong earnings rebound that analysts currently expect. It’s a view the market seems to share, which explains the bank’s low P/E ratio of just 8 times.
Some of the threats the bank faces (like low economic growth and rising competition) threaten to plague its prospects over the long term too.
So despite the cheapness of Lloyds shares, I’d rather buy other FTSE 100 shares today.
This post was originally published on Motley Fool
