Do the rewards outweigh the risks in Lloyds share price?

The Lloyds (LSE: LLOY) share price is up 46% from its 10 January 12-month traded low of 52p.

However, there could still be value left in the shares, as price and value are not the same thing. I took a deep dive into the business and ran key numbers to ascertain whether there is indeed value here.

The share price

A quick and broad indicator of whether there may be value left is the earnings growth forecasts for the bank. It is expansion here that ultimately drives any firm’s share price (and dividends) higher over time.

In Lloyds’ case, consensus analysts’ forecasts are that its earnings will increase by 15% a year to the end of 2027. This compares strongly to the 7.9% average earnings growth projected for the UK banking sector over that period.

So this is a promising start that there could be significant value left in Lloyds shares, in my view.

The valuation

One effect that a rapid price rise may have on a share is to make it look expensive on key comparative indicators.

This is true here, with Lloyds appearing overvalued against its banking peers on two of the three key indicators I trust most.

For example, on the price-to-earnings ratio, Lloyds currently trades at 11.8 against a peer average of 9.6. These comprise Barclays at 8.5, NatWest at 8.6, Standard Chartered at 10.4, and HSBC at 10.7.

It is also overvalued – albeit slightly – on its 1 price-to-book ratio against the 0.9 average of its competitors.

However, on the price-to-sales ratio it looks fairly valued at 2.6 – the same as its peers’ average.

Given this, I ran a discounted cash flow analysis to get to the bottom of Lloyds valuation. This pinpoints where any firm’s share price should be, centred around cash flow forecasts for the business.

This shows Lloyds shares are 45% undervalued at their present price of 76p.

Therefore, their fair value is £1.38.

Will I buy the stock?

Lloyds’ strong earnings growth projections are sufficient for my personal stock screener to bring it to my attention. And I do not doubt that over time these will power its share price (and dividends) higher.

However, my problem here stems from the fact that I am well over 50. Therefore, I am in the latter part of the investment cycle.

This means that I cannot afford to take the level of risk in stocks that I did when I was younger. Quite simply: the earlier a person is in the investment cycle, the greater the chance their stocks have to recover from any shock.

And there are some big risks here, I think. One is the as-yet unidentified level of compensation that Lloyds may have to pay for mis-selling car insurance.

Another is the prospect of falling interest rates in the UK – its key market – which can reduce its net interest income. This is money made from the difference in loan and deposit rates.

And the final major one is the volatility risk that comes from a sub-£1 share price. Each 1p of Lloyds share price represents 1.3% of the stock’s entire value!

Nonetheless, for younger investors for whom these risks are less acute I think it is worth considering.

The post Do the rewards outweigh the risks in Lloyds share price? appeared first on The Motley Fool UK.

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HSBC Holdings is an advertising partner of Motley Fool Money. Simon Watkins has positions in HSBC Holdings and NatWest Group Plc. The Motley Fool UK has recommended Barclays Plc, HSBC Holdings, Lloyds Banking Group Plc, and Standard Chartered Plc. 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.