martinrlee/iStock Editorial via Getty Images My quest to find stocks that are likely to hold up well and possibly thrive in 2023 continues. Fears of a recession are still possible in 2023 as higher interest rates suppress lending and other economic activity. With that in mind, Lloyds Banking Group plc (NYSE:LYG) was found to be a stock that is likely to thrive during this uncertain time. The company has a low valuation along with strong potential growth. This combination can help drive the stock higher for above-average gains in 2023 and beyond. Lloyds Banking Group ranks as the second top publicly traded bank in the U.K. behind HSBC Holdings (HSBC) according to market cap. HSBC is the largest with a market cap of $142 billion, while Lloyds has a market cap of $43 billion. Lloyds Driving Strong ROE Growth Return on Equity [ROE] growth is an important metric for banks because it measures the bank’s ability to generate profit from shareholders’ equity. A growing ROE indicates that the bank is effectively using its equity to generate profit, and that it is becoming more efficient in its operations. This can increase the value of the bank’s stock and attract more investors. Lloyds achieved an ROE of about 8% over the past 12 months. The better news is that the company is expected to achieve ROE growth of 50% this year. That growth would bring the ROE up to 12%. Additionally, ROE growth can also indicate the bank’s ability to weather economic downturns, as a growing ROE suggests that the bank is becoming more resilient. This can be particularly important for Lloyds as they operate in a highly regulated and competitive industry and must demonstrate stability and sustainability to remain attractive to customers and investors. This is also important due to the fragile nature of the economy in the U.K. in the face of higher interest rates and a possible recession. The Economic Outlook for the U.K. The International Monetary Fund [IMF] has a pessimistic view for the U.K. in 2023. The IMF believes that the U.K. will be the only advanced economy to contract by 0.6% in 2023. This forecast was recently lowered by the IMF by 0.9 percentage points at the end of January. The IMF cited that the U.K.’s high exposure to higher natural gas prices would likely be passed onto consumers. Natural gas prices tend to run higher in the U.K. than in the U.S. The IMF also cited that employment was lower than pre-pandemic levels even though the labor market is tight. This is creating less production. The IMF also stated that sharp monetary tightening contributes to the low forecast. The good news is that the IMF is forecasting growth to return in 2024 with an economic expansion of 0.6% to 0.9%. The bank rate was increased on February 2 by 0.5% to 4% in an effort to lower inflation. The Bank of England sees inflation beginning to ease and they expect inflation to reach its target of 2% in the second quarter of 2024. Currently, the inflation rate is about 10% in the U.K. The Bank of England is projecting an economic decline of 0.5%, which is lower than its previous forecast of a 1.5% contraction. Implications of the Economic Outlook for Lloyds It doesn’t look like we will experience anything like the financial crisis of 2008 in 2023. While there are risks in the economy, consumers are not overleveraged like they were prior to the financial crisis according to household debt. Household debt as a percentage of disposable income peaked at 155.6% in 2008. This dropped to the 130s currently. This should help Lloyds hold up well in 2023. Lloyds sees some bright spots for its outlook in 2023 according to its January barometer. Business confidence increased by 5 points to 22% and economic optimism increased 4 points to 47%. Manufacturing and the service industry saw increased confidence, while retail confidence declined to a 2-year low. Lloyds has been benefitting from increasing interest rates since it boosts its net interest income. Higher interest rates increased the spread between the amount the bank pays out in interest and the return it generates from lending. For example, net interest income of $13.4 billion was achieved by Lloyds just in the first 3 quarters of 2022 as compared to the $11 billion that Lloyds achieved in all 4 quarters of 2021. Lloyds is scheduled to report Q4 on February 22. So, we will see what the full year of net interest income for 2022 was at that time. The Dividend Lloyds currently has a 4% dividend yield. The company has been paying dividends every year since 2015. No dividends were paid from 2010 to 2014. Also, the amount of the dividends on an annual basis can be choppy with higher payments paid in 2019 as compared to 2021 and 2022. So, Lloyds is not a dividend aristocrat, but it does have an attractive yield currently. Since the company has been performing well, I would expect Lloyds to continue paying dividends in 2023. Reasonable Valuation I like to use the price/book ratio to evaluate banks. The reason for this is because it evaluates the company based on its assets and liabilities. Lloyds has 1.05x more total assets than total liabilities for a book value of $51.8 billion. The company is trading with a price/book ratio of 0.83. This is the same as the Regional Banking industry’s price/book ratio. So, Lloyd’s is trading right at the industry average. I like to see banks trade with a price to book below one. Lloyds is attractively valued below one as the book value is higher than the market cap. The stock has room to the upside from this valuation in my opinion. Technical Perspective tradingview.com The recent rally in the stock looks to have run out of steam as the price dropped from its previous overbought level according to the RSI (purple line at the bottom of the chart) on the daily chart. The MACD looks like it is about to make a bearish crossover as the blue line in the middle section of the chart might cross below the red signal line. Given the technical look, I don’t think this is the ideal time to jump into the stock. I expect a little pullback in the stock to take place on profit taking. Then, I would wait for the RSI to cross above the yellow line and the blue MACD line to cross above the red signal line after the pullback before starting a position. This occurred in October as you can see in the chart. There might be a better entry point in a few weeks. Lloyds Investment Outlook Overall, Lloyds should continue benefitting from the higher interest rate environment as it helps drive higher net interest income. One of the largest risks for the company would be a significant decline in the U.K. economy. If the economic conditions became worse than expected, then it could hurt the company’s lending business. However, there might be a balance between rising interest rates and a decline in inflation that could keep conditions attractive for Lloyds. This appears to be the company’s perspective at the moment. Investors should consider waiting for the Q4 report on February 22 to see if Lloyds changes its guidance for 2023. This will also allow the stock to pullback a bit from its previous overbought condition. I expect the stock to perform well in 2023 after the current pullback is over. The performance is likely to be driven by strong net interest income growth.
