Lloyds (LSE: LLOY) share price has dropped from its 4 February one-year traded high of £1.14 to just above the £1 level.
And this has exacerbated the already glaring mismatch between the stock’s ‘fair value’ and its price. That value figure factors in the fundamentals of the underlying business rather than the short-term noise reflected in a stock’s price.
This difference is enormously useful for long-term investors to know, as share prices tend to converge to this fair value over time.
So, what level are we looking at here for the true worth of the stock?
What do the fundamentals show?
Long‑term investors like me are ultimately buying a stream of future business cash flows, not a 12‑month market mood swing. And cash flows are in large part derived from earnings growth.
A risk here for Lloyds is any tightening in regulatory capital requirements that would reduce this free cash flow. Another is a sharper‑than‑expected rise in loan impairments that could eat into the bank’s earnings.
Nonetheless, analysts forecast that Lloyds earnings will grow by an annual average of 10.1% over the medium term at least. And this looks well supported to me in its latest results — Q1 2026, released on 29 April.
These saw profit before tax soar 33% year on year to £2bn. And the bank also restated its return on tangible equity target — a key profit marker for banks — of over 16% for the full year.
So where’s fair value for the shares?
As a former senior investment bank trader, I found the best way to identify where a stock ought to trade is discounted cash flow (DCF) analysis. It projects future cash flows for the underlying business and discounts them back to today to produce a per-share value.
The discount applied to these cash flows rises, the less certain the forecasts are. Because analysts sometimes choose different assumptions, their DCF modelling results can diverge. But using my own framework — including an 8.4% discount rate — Lloyds appears 48% undervalued at its present £1.02 price.
That suggests a fair value of £1.96 — nearly twice the present level. So, if stock prices continue their historical pattern of converging to fair value, this looks a tremendous potential buying opportunity if that DCF modelling proves accurate.
My investment view
I already hold shares in HSBC and NatWest, so buying another banking stock would disrupt the balance of my portfolio.
If I did not have this problem, I would buy Lloyds shares now. They appear enormously undervalued, and the bank’s strong earnings growth is likely to push the price to fair value over time, in my view.
But I would also buy it for its rising dividend yield potential. In this context, analysts forecast this will rise from the present 3.8% to 6.1% by 2028. By contrast, the current FTSE 100 average is just 3.1%.
This is why Lloyds is going on my watchlist if either of my current banking holdings starts underperforming.
In the meantime, deeply discounted shares in other sectors — also with very high dividend yields — have recently caught my attention.
Should you invest £5,000 in Lloyds Banking Group Plc right now?
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Simon Watkins owns shares in HSBC and NatWest.
