At 42p, are Lloyds shares a bargain or a value trap?

There are two cases to be made for the Lloyds share price. Here, I weigh the pros and cons of an investment in the banking stock right now.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Middle-aged white man pulling an aggrieved face while looking at a screen

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

RISK WARNING: should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice. The Motley Fool believes in building wealth through long-term investing and so we do not promote or encourage high-risk activities including day trading, CFDs, spread betting, cryptocurrencies, and forex. Where we promote an affiliate partner’s brokerage products, these are focused on the trading of readily releasable securities.

The Lloyds (LSE:LLOY) share price is suffering along with other top finance shares in the UK. Rampant inflation is forcing global economies to raise interest rates. Today, news broke that the US government is considering another increase after it rolled out its largest hike in 28 years just last month. Here in the UK, the Bank of England has suggested that inflation could hit 11% in October.

And now, a new Covid lockdown in China is rekindling concerns from 2021. This could trigger another mini-collapse, causing shares to dip further. But I think preparing for a crash is the best investing strategy I have learnt in the last two years. Given the current economic climate, should I consider adding cut-price Lloyds shares to my portfolio if markets slide further? 

The bull case 

Yes, interest rate hikes mean banks will generate more cash on past and future loans. And for Britain’s largest lender, this is a welcome boost. And the recent analyst estimates for Lloyds look flat but I also see some positives. 

Currently, the estimates suggest that overall annual revenue from 2022-26 will remain between £4.5bn and £4.7bn. This tells me that the overall cash flow could remain stable, which is a good sign for Lloyds’ dividend. And Lloyds shares receive high investor interest throughout the year, largely thanks to its robust 4.75% dividend yield. 

Another positive I see over the next few years is an increase in business loans. Historically, periods of inflation have led to higher rates of borrowing among small and medium-sized businesses. And this ties in well with free cash generated. The Lloyds dividend has an earnings cover of 3.7 times, which is a strong sign that the company can sustain its current yield. And given the estimates for the next few years, I think I can expect a steady payout from Lloyds shares, which would make it a bargain on paper.

The bear case

While banking stocks stand to earn from more than one source, increased interest rates are not a good sign for the UK economy. Consumer goods brands are already seeing smaller baskets and measured spending as budgeting becomes a priority. And the housing boom in the UK looks like it is slowing down. This is bad news, particularly for Lloyds shares. 

We could just be entering a cyclical housing bear market in the UK after a decade of high demand. Lloyds bank earns a major chunk of its revenue from housing mortgages and it also recently invested in residential plots in the UK. This move could easily backfire with a housing collapse. And the Lloyds share price could fall as a result, which puts my investment at risk of falling into a value trap. 

The current instability is a big red flag for me and is keeping me from investing in any finance share in the FTSE 100. Yes, I think Lloyds is a strong business that will continue to generate cash for the foreseeable future. But other exciting areas are cropping up in the UK that could be better for my portfolio. I am looking at some top UK energy and tech shares right now. And I am steering clear of Lloyds and other finance stocks at the moment while looking for signs of a recovery.

RISK WARNING: should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice. The Motley Fool believes in building wealth through long-term investing and so we do not promote or encourage high-risk activities including day trading, CFDs, spread betting, cryptocurrencies, and forex. Where we promote an affiliate partner’s brokerage products, these are focused on the trading of readily releasable securities.

Suraj Radhakrishnan has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

Publish Test

Lorem ipsum dolor sit amet, consectetur adipiscing elit. Sed do eiusmod tempor incididunt ut labore et dolore magna aliqua. Ut…

Read more »

Investing Articles

JP P-Press Update Test

Read more »

Investing Articles

JP Test as Author

Test content.

Read more »

Investing Articles

KM Test Post 2

Read more »

Investing Articles

JP Test PP Status

Test content. Test headline

Read more »

Investing Articles

KM Test Post

This is my content.

Read more »

Investing Articles

JP Tag Test

Read more »

Investing Articles

Testing testing one two three

Sample paragraph here, testing, test duplicate

Read more »