Warren Buffett likes large-cap stocks. He also likes banks. Currently his company, Berkshire Hathaway, has positions in JP Morgan Chase, Bank of America, Bank of New York Mellon, M&T Bank Corporation, US Bancorp, PNC Financial and Wells Fargo.
Would Buffett buy Lloyds Bank (LSE: LLOY) shares though? Here’s my take.
Competitive advantage
Let’s first consider Lloyds’ competitive advantage, or ‘economic moat’ as this is one of the first things Buffett looks for in a prospective investment. “The most important thing is trying to find a business with a wide and long-lasting moat around it,” Buffett has said.
Lloyds’ size does give it some form of competitive advantage. With 30m customers (including 13m online active users) and 2,000 branches across its main brands, Lloyds is the largest provider of retail banking services in the UK.
This gives the company cost advantages. Indeed, Lloyds’ website states: “Our market-leading cost position and customer franchise are sources of competitive advantage.” I do think this would appeal to Buffett.
That said, to retain its competitive advantage, Lloyds needs to ensure it continues to evolve into a more digital bank, in my view, as banking is changing rapidly due to the rise of fast-growing digital banks such as Revolut, Monzo, and Starling. According to research from Accenture, UK digital banks will see their combined customer base rise from around 13bn people to 35bn over the next year.
To Lloyds’ credit, it has said it won’t be complacent here and that it will further digitise the group in order to drive operational efficiencies and improve the experience for customers. It also plans to simplify and transform its IT architecture in order to use data more efficiently.
Overall, I think Buffett would be impressed with Lloyds’ position in the market and its strategy to evolve.
Capital returns
Buffett has also taken a liking to companies that distribute capital to shareholders by way of dividends or share repurchases. In his 2016 letter to shareholders, he said: “Many of our investees, including Bank of America, have been repurchasing shares, some quite aggressively. We very much like this behavior because we believe the repurchased shares have in most cases been underpriced. When a company grows and outstanding shares shrink, good things happen for shareholders.”
Here, I think Buffett would also see appeal in Lloyds. Earlier this year, the group announced it would repurchase £1.75bn worth of shares (although it recently suspended the last £600m of buybacks due to the last-minute surge in PPI claims).
In addition, Lloyds has paid a big dividend to shareholders in recent years. Last year, the group paid out 3.21p in divis which, at the current share price, equates to a yield of 5.4%.
Valuation
Finally, we know Buffett loves a bargain. He likes to buy stocks when they’re a little out of favour. Given that Lloyds shares currently trade on a forward-looking P/E ratio of just eight (compared to around 15 for the FTSE 100), I think he could be interested.
All things considered, I believe Lloyds shares could be tempting to Buffett. Ultimately, the business is an industry leader that’s trading at a rock-bottom valuation.
