Banks are some of Warren Buffett’s favourite businesses. But how does the Lloyds share price compare to the other UK banks? Which should I buy to follow Buffett’s example?
The UK’s four biggest banks are Lloyds Banking Group, Barclays, NatWest Group, and HSBC Holdings. While they have certain similarities, there are also important differences.
HSBC is the most distinctive. All of the four make money by taking in deposits at one rate and lending money out at another rate. But HSBC also gets substantial income from trading securities. Additionally, HSBC has a much broader international footprint than Lloyds, Barclays, or NatWest.
This means that HSBC is more diversified than the others. This can be good or bad. It means that when the UK lending environment is difficult for banks — when interest rates are low, for example — HSBC has other income sources to fall back on. But it also means that HSBC stands to benefit less when economic conditions in the UK are more favourable.
In assessing bank stocks, I’m looking for three things: a quality operation, a reasonable share price, and no excessive risk.
To assess quality, I’m using two metrics. The first is net interest margin, which measures the efficiency of a bank’s lending. The second is return on equity which measures the efficiency of the bank as a whole (including its income from lending as well as other operations).
Higher numbers are better in both cases. Here’s how the four UK banks stack up:
|Net Interest Margin||Return on Equity|
From this, it’s reasonably clear to me that Lloyds has the edge when it comes to quality.
Having assessed the returns on equity, the next thing to look at is the amount that I’d have to pay for that equity. To do this, I’m looking at the price-to-book (P/B) ratio of each bank. The ratio is the result of comparing the bank’s share price to the value of the equity each share represents.
This time, a lower number is better. Here are the P/B ratios for the UK banks:
None of these is exceptionally high. But Barclays shares trade at the lowest price relative to the company’s book value.
In evaluating risk, I’m going to look at each bank’s common equity tier 1 (CET1) ratio. The ratio is the result of expressing the bank’s core capital as a percentage of its assets weighted by risk. It’s designed to measure how well a bank might hold up in difficult economic times. Generally, a higher number indicates that a bank carries less risk and a number below 4.5% is a cause for concern.
Here is each UK bank’s CET1 ratio:
All of the banks score strongly here, though Barclays comes out on top.
Overall, I’m drawn to Lloyds. All of the banks have strong risk scores. And I think that the higher quality of Lloyds outweighs the cheaper valuation of Barclays. Obviously, looking at the numbers is just one part of investing. The next thing is to look more closely at each bank’s future prospects. But from I’ve seen so far, the Lloyds share price seems most attractive to me.