Warren Buffett is one of the most successful investors of all time, and as of today, he is the fifth richest person in the world. In the 2008 letter to Berkshire Hathaway‘s shareholders, Buffett wrote “Price is what you pay; value is what you get.” Before Covid-19, Lloyds Banking Group (LSE: LLOY) shares were trading at around 65p. I do believe there are reasons for me to be bullish on this stock and it could return to trading at pre-Covid prices, but there are also risks to be aware of.
Interest rates are the key
Rising inflation is often accompanied by interest rate hikes, as we’ve seen in the last couple of months in the UK and the US. Banks look at interest rates hikes like kids look at sweets. They generate a large portion of their revenue from the spread between the rates they charge to lend money and the rates they offer to borrow it. When rates are higher, they have more margin to widen the spread.
This year, the Bank of England (BoE) and the US Federal Reserve (FED) have raised interest rates. The last BoE meetings resulted in interest rate hikes three times in a row. Meanwhile, the FED has hiked once already and we could see as many as five or six more hikes this year, and possibly three or four more in 2023.
However, I need to be aware that due to rising inflation and the cost of living, people are less likely to take out loans from banks. That would not count in the company’s favour.
Lloyds makes the move
Lloyds has announced it will shut 60 branches across the UK. The bank said “The public’s shift to online banking meant that fewer customers were now visiting its branches”. With this strategy, the bank wants to reduce its day-to-day overheads and eventually increase the likelihood of higher earnings. That’s good news for shareholders.
However, there are still people who prefer to visit a branch. As a result, Lloyds may lose customers as they shift to competitors who have physical branches.
What I’d do
Warren Buffett has previously stated that “whether we’re talking about stocks or socks, I like buying quality merchandise when it’s marked down”. I have no doubt Lloyds is a great business holding a lot of potential. It is also worth noting that its price-to-earnings (P/E) ratio is just 6.4 and the price-to-sales (P/S) ratio is below 1. That’s dirt-cheap.
Increased interest rates have the potential to both benefit or harm the company. Yet wider factors such as its low valuation and strong dividends, for me, make Lloyds Banking Group shares appealing. I think the share price offers great long-term value. Therefore, I think this is a stock that Warren Buffett would be willing to look into further.
