Is the Lloyds share price seriously undervalued?

Image source: Getty Images

the Lloyd’s (LSE: LLOY) The stock price looks cheap to me relative to its trading history. Towards the end of last week the stock was changing hands for around 50p, down from around 55p at the start of the year and over 64p before the start of the coronavirus pandemic.

If we go back to 2018, the stock was trading above 70p. However, a company’s stock price tells us little about the underlying fundamentals of the company.

It only shows us how market sentiment has changed over a short period of time.

It’s the past, but I prefer to look ahead. And I think the stock looks cheap relative to its potential when analyzing the company’s underlying fundamentals and growth prospects over the next few years.

Profits up

2021 turned out to be a great year for the lender. Thanks to the explosion in demand for mortgage loans, it recorded exceptional growth in its profits. Net profit reached £5.8 billion in 2021, compared to £1.3 billion in 2020.

Unfortunately, analysts do not expect this trend to continue. They forecast a nearly 30% drop in profits for the current fiscal year.

But even after factoring in that decline, Lloyds’ share price looks relatively undervalued to me. It is selling at a price/earnings (P/E) multiple of just 8.2. The current market average is 14. So, based on that, stocks could well be cheap.

The stock is also selling at a price/book value (P/B) of 0.7. In theory, any sustainably profitable company should sell at a P/B value of one or more.

Both of these numbers suggest that stocks are undervalued.

Risks for my investment file

Using only the P/B value, it looks to me like the stocks are undervalued by about 42%.

That being said, I can’t take these numbers for granted. The cost of living crisis could have a significant impact on the bank’s profitability. If the housing market slows, demand for mortgages could also fall. This would have a significant impact on profitability and interest income.

Rising interest rates could offset some of this decline. Yet if the economic situation deteriorates significantly, as one of the UK’s largest financial institutions, Lloyds will almost certainly suffer.

I think these potential headwinds are the main reasons why the market is placing such a low multiple on the stock. There is so much uncertainty surrounding the outlook for the company that it is difficult for me to say whether or not the shares will trade at a higher valuation anytime soon.

However, even after taking these risks into account, I believe that over the next five to ten years the Lloyds share price will begin to reflect the underlying fundamentals of the business. That’s why I would buy the stocks for my portfolio today.

I think it’s seriously undervalued relative to its long-term potential.

Richard L. Militello