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For most of the last decade, many investors assumed that a normalization of interest rates would be a positive catalyst for Lloyd's (LSE: LLOY) shares.
Has this been the case? Well, in November 2021, when the Bank of England started raising rates to more normal levels, the share price was 49p. Today it is at 42p, so this theory has not been fulfilled.
Currently, some investors think that cut in interest rates could be a big catalyst for stock prices. So it's like there's always one last piece missing.
Alternatively, of course, Lloyds' share price could be like the play. Waiting for Godot, where the characters wait endlessly for the arrival of someone who never appears.
That is, investors waiting for market conditions or other factors to align favorably could find themselves trapped in a perpetual cycle of hope and disappointment.
So, given this possibility, why have I been buying the shares?
Safety margin
First of all, the shares are very cheap. And while I doubt Lloyds shares will ever be highly valued again, I don't think they will get much cheaper either (famous last words).
It is currently trading on a price-to-earnings (P/E) ratio of just 6.3 for the next 12 months. That's considerably cheaper than the FTSE 100 average of around 11.
Its price-to-book (P/B) ratio, which compares its market valuation to net assets, is 0.63. Of course, it may not reach its fair value (1) again anytime soon, but this suggests the stock is significantly undervalued.
Overall, I can't help but think that this valuation provides a solid margin of safety for investors. The chart below seems to suggest the same thing as well.
High-yield income prospects
Plus, passive income prospects look as good as ever right now.
Analysts expect Lloyds to pay 2.78 pence per share in dividends by 2023, followed by 3.15 pence per share by 2024. At the current share price of 42.7 pence, these potential payouts translate into yields of 6. 4% and 7.3%.
Of course, no dividend is guaranteed. But the dividend coverage ratios for 2023 and 2024 are 2.7 and 2.1, respectively. Since a ratio of two generally suggests that a company's payment is secure, I find this reassuring.
Risks
Now, there are still a couple of risks here.
Firstly, the UK economy officially entered recession at the end of last year. Economists predict this is a relatively shallow slowdown, but it still adds risk to banking stocks, especially Lloyds, which focuses on the domestic market.
The recession could force cuts in interest rates, which could eat into profits somewhat.
Additionally, the Financial Conduct Authority's investigation into discretionary commission arrangements (DCAs) in the car finance market could be an issue here. Lloyds is a major player in car finance and could face a huge fine.
In fact, some fear this could become another PPI-style scandal. It's too early to tell, but it's worth keeping in mind.
I would still invest for income.
Despite these risks, Lloyds still strikes me as a stock that could deliver dividends for many years to come.
My strategy then is to automatically reinvest my dividends into buying more Lloyds shares. I don't do that with all my income stocks, but I'm here. By doing so, I can let compound interest do its work over time.
