Trading around a 10-year high, is Lloyds share price overpriced against ‘fair value’ now?
Lloyds (LSE: LLOY) share price is only a couple of pennies off its 16 September one-year high of 84p. This level had not previously been seen since July 2015.
However, it is important to remember that a stockâs price and value are not the same thing. Its price is whatever the market is willing to pay for it at any given moment. But its value is founded on key fundamentals relating to the underlying business.
In this sense, price is largely irrelevant to my long-term investment decisions: it is value in which I am interested.
Is there any value left in this stock?
The best way of ascertaining value is through discounted cash flow (DCF) analysis, in my 35+ years of investment experience. Several of these were as a senior investment bank trader, with the remainder as a private investor.
What the DCF does is to identify precisely the price at which any stock should be trading. It achieves this by using cash flow forecasts for the underlying business.
This is in part derived from earnings growth projections for the firm. It is ultimately these, in fact, that determine the trajectory of any companyâs share price and dividends â higher or lower.
A risk to Lloyds is a further deterioration in the UK economy. After all, any bankâs business reflects the economic well-being of the major markets in which it operates.
That said, consensus analystsâ forecasts are that Lloyds earnings will grow by a very robust 11.9% a year to end-2027.
Against this backdrop, the DCF for the bank shows its shares are 38% undervalued at their current 82p price.
Therefore, their fair value is £1.32.
It is also apposite to say here that in my experience asset prices tend to converge to their fair value over time.
A rising dividend yield forecast too
A shareâs dividend yield moves in the opposite direction to its price, provided the annual dividend stays the same. So, Lloyds’ big share price rise over the past year has pushed its dividend yield down to 3.9%.
However, analysts forecast that the bank will increase its dividend this year to 3.54p, next year to 4.15p, and in 2027 to 4.76p. This would produce respective dividend yields (given the current share price) of 4.3%, 5%, and 5.8%.
So, an investor considering a £10,000 holding in Lloyds would make £7,835 in dividends after 10 years. This would rise to £46,735 after 30 years.
With the initial £10,000 investment included, the total value of the Lloyds holding would be £56,735 by then.
And this would pay £3,291 a year in dividend income by that point.
All these figures are based on the 5.8% dividend yield forecast, and on dividend compounding. This is simply reinvesting the dividends paid out straight back into the stock.
My investment view
High earnings growth forecasts, a major undervaluation, and a rising dividend are three reasons worthy of attention by any investor.
However, for me, there are two reasons why I am not buying the stock. The first is that I already have two bank shares â HSBC, and NatWest â and any more would unbalance my portfolio.
The second is that Lloydsâ sub-£1 share price adds price volatility risk to the investment mix, which I do not want.
The post Trading around a 10-year high, is Lloyds share price overpriced against âfair valueâ now? 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 HSBC Holdings and Lloyds Banking Group 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.
