The Lloyds (LSE:LLOY) share price lost a chunky 8% of its value in 2022. But investor demand for the FTSE 100 bank has picked up in New Year trading. Could the market be betting that the bad news is now baked into the company’s current valuation?
On paper, Lloyds shares certainly look cheap. They trade on a price-to-earnings (P/E) ratio of 6.5 times. This is well below the FTSE index average of around 13.5 times.
Should value investors buy the Black Horse Bank for their portfolios? Or do the risks facing the bank remain too severe?
A gloomy outlook
I’ve been reluctant to buy Lloyds shares for my own portfolio. I’ve been put off by the massive sums it’s had to put aside in recent months to cover bad loans.
This totalled more than £1bn between last January and September. More shocking loan impairments could be coming down the pipe when full-year financials come out on 22 February, too.
Retail banks are highly sensitive to economic conditions. So predictions that the UK economy will keep shrinking until well into 2024 have made me pretty nervous. I’m envisioning a steady rise in bad loans and a prolonged period of weak revenues.
… or is it?
These gloomy forecasts are shared by economists far and wide. The Bank of England, Office for Budget Responsibility, and Goldman Sachs are just a handful of bodies predicting weak economic conditions until next year.
However, some predict that the UK economy may not perform any worse than other major economies. Take Oliver Rust, head of product at independent inflation data aggregator Truflation, for example.
Rust has said that “the UK is certainly in a tough spot, but whether it will suffer more than any other economy in the G7 — and as much as Russia — I am not sure”. He continued that “many European countries and also Japan are facing similar challenges and it seems unlikely the UK will be significantly worse-off”.
The OECD predicted in late November that Britain’s economy would be the worst among a group which also includes Canada, France, Germany, Italy, Japan, and the US.
Such worries have been particularly bad for the Lloyds share price in 2022. This is due to the company’s focus on the UK. So a better-than-expected economic performance on these shores could help sweep the FTSE 100 bank higher again if they translate to better profits.
The verdict
As a value investor, I see obvious appeal in Lloyds shares. But right now I remain reluctant to buy them for my portfolio.
I’m not just concerned about the short-term earnings outlook. I think the bank could be set for prolonged pressure as the UK adjusts to post-Brexit life and other major structural challenges. Low productivity, high national debt, and a steady manufacturing decline are just a few problems that could sap GDP growth.
I’m also worried about Lloyds’ future profits as competition from digital and challenger banks grows. It faces a steady decline in market share as consumers respond to online-led operators. All things considered, I’d rather buy other cheap UK shares today.
