The Lloyds (LSE: LLOY) share price has been an underwhelming investment to own over the past 10 years.
However, I believe that all of the pieces are now in place for the business to charge ahead. And I think it is likely this improving operating performance will enhance investor sentiment, pushing the stock higher in the years ahead.
Pieces in place
The lender has only really just started to recover from the financial crisis. For most of the past decade, the group has been focused on cutting costs, improving efficiency and diversifying its operations.
These initiatives have generated results, but interest rates have remained the elephant in the room. Interest rates have been held near-zero consistently since the financial crisis, preventing financial institutions like Lloyds from making a full recovery.
This is changing. The Bank of England is expected to increase interest rates several times over the next year. This will allow lenders such as Lloyds to increase rates charged to customers. For the first time in a decade, it should be able to generate a significant increase in lending margins.
As lending accounts for the vast majority of the company’s business, higher rates could lead to a dramatic increase in returns on equity, a crucial measure of banking profitability, calculating the rate of return for every £1 invested.
Over the past decade, Lloyds has been trying to improve its return on equity by diversifying into wealth management, buy-to-let investing, and expanding its credit card business. These initiatives have produced results, but its hands were tied without an interest rate hike.
Lloyds share price re-rating
As the environment changes, I think the market will rethink its opinion of the business. Investors have been wary of buying the shares in the past, due to the uncertain interest rate environment. Now the environment is improving I believe market sentiment will change.
That is why I think the outlook for the Lloyds share price has never been so exciting. Over the next couple of years, I believe the stock will benefit from the twin tailwinds of growth and improving market sentiment. Investors may be willing to pay more for the stock as growth returns.
The combination of higher earnings and a higher earnings multiple is likely to produce a favourable environment for the enterprise.
Having said all of the above, there are some challenges to consider. Interest rates may not rise as high as some analysts expect. A sudden economic downturn could cause the Bank of England to reverse course. This would pull the rug out from underneath the bank.
What’s more, the banking industry is highly competitive. Due to competitive forces, Lloyds may not be able to increase the interest rate it charges to customers significantly. This could hold back growth.
Still, despite these challenges, I would be happy to buy the stock from my portfolio today, considering the positive factors outlined above.
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. 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.
