Banking group Lloyds (LSE: LLOY) strikes me as something of a bellwether for the UK financial services sector, given its domestic focus and status as the nation’s biggest mortgage lender. But while the wider economy has been stuttering, the Lloyds share price has added 11% in the past 12 months.
Can this upwards trend continue – and should I add the share to my portfolio?
Reasons to be cheerful
From a straightforward valuation perspective, I think the rise in the Lloyds share price is understandable. I also reckon it could continue.
The bank trades on a price-to-earnings ratio of just 8. For a highly profitable bank with a large customer base, strong brands and a leading market position, that seems cheap.
Set against that there are potential risks from an economic downturn. But arguably even that is a double-edged sword for the black horse. Take rising interest rates as an example. If they lead more borrowers to default on their mortgages, that could push up the number of bad loans on Lloyds’ book.
But higher interest rates could also give the bank more leeway to boost profits lending out money at higher rates than they give to depositors.
That basic banking business model can work even with low interest rates. But the scope for a bigger gap between lending and deposit rates gets broader as interest rates increase.
Possible economic headwinds
Yet if the current Lloyds share price really is good value, why have investors not been snapping up the stock? Maybe to some extent they have. That could be why the shares have put on 11% in a period when the FTSE 100 index as a whole has only increased 2%.
But I think some investors are concerned about the possible risks to profits at banks if the UK economy gets seriously weaker. Indeed, that is why I sold my Lloyds shares this year.
Such a risk is not limited to Lloyds. A harsh recession could be bad news for all banks to some degree. But rivals including HSBC, Barclays and Standard Chartered have sizeable international businesses. That could help them if the UK economy performs worse than international ones.
By contrast, Lloyds’ local focus could be a drag on performance if the UK economy struggles more than many of its peers.
My move on the Lloyds share price
Lloyds has a 4.4% dividend yield that is very well-covered. So I could choose to buy the shares now, take the dividends and wait for the economic storm to pass.
But that does not appeal to me. While the Lloyds share price may keep on rising, it could also fall if the economy gets into deep trouble. It has almost doubled in just under two years. If things get bad, the bank may also decide to suspend its dividend. Lloyds did so both following the last financial crisis and at the start of the pandemic, when it was required to do so by its regulator.
I think other companies are less exposed to the risk of an economic downturn. So, although I think the Lloyds share price could continue rising, I will not be buying the shares again any time soon.