Are Lloyds shares the bargain they seem?

·3-min read
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A couple of years ago I was excited about the prospects for Lloyds (LSE: LLOY). Since then, though, I have sold my Lloyds shares.

But the strengths I saw back then, such as a well-known brand, market-leading mortgage book, and large customer base, are all still there today. Not only that, but the current valuation looks cheap on many metrics.

Am I missing something?

Cheap valuation

Let’s begin with the valuation.

The bank trades on a price-to-earnings ratio of just six. For a FTSE 100 name like Lloyds, that looks very cheap. It means that, in theory at least, a suitor could buy the bank today, pay the cost with earnings from the next six years, then own it debt-free.

A different approach to valuing bank shares is looking at the price to book value ratio. Again, Lloyds comes off favourably using this approach.

The bank’s first-quarter results published last week also seemed to suggest business is strong. Statutory profit came in at £1.6bn, a 43% increase over the same period last year. The bank’s market capitalisation is £30bn – and it earned 5% of that amount in just one quarter.

But, if the bank is so good, why are Lloyds shares now 30% cheaper than five years ago?

Difficult times

I think the answer to that can be summed up in one word: uncertainty.

All businesses face some uncertainty and that affects their share prices too. But right now, for banking shares, I think there is considerable uncertainty of the wrong sort.

This is not uncertainty of the type we see in some sectors, of whether results will come in with expectations or storm past them. Rather, it is uncertainty about the outlook for banking – will things sail on as they are, or could they get much worse?

This year has seen some of the biggest bank failures in US history. Europe has also seen trouble, as seen in the takeover of Credit Suisse.

So far, so distant. One of the strengths (but also weaknesses) of Lloyds’ business model is its domestic focus. For now, at least, it seems to be sailing on smoothly. But banking crises are contagious. They come about because of a lack of confidence. Sometimes that has nothing to do with the underlying strength of the banks concerned. But a lack of confidence can be damaging whether or not it is justified.

Possible bargain

In my opinion that means that there is uncertainty about the short- to medium-term outlook for all UK banks, including Lloyds.

That could present a buying opportunity for investors. Lloyds seems to have a bargain valuation, with a 5.3% yield to boot. If the banking crisis fades into memory and investors focus on the underlying strength of the business, I think Lloyds shares could move up from here.

However, I will not be buying them any time soon. There is simply too much uncertainty about the outlook for banks, as strained household budgets and high interest rates increasingly rub against each other. I am not comfortable with the risk that poses to investor confidence. I think Lloyds shares are cheaper now than five years ago for a reason, which is the market’s uncertainty and nervousness about what is in store for banks in the next couple of years. I shall not be investing.

The post Are Lloyds shares the bargain they seem? appeared first on The Motley Fool UK.

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C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended 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.

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