Fear in the market has continued amid uncertainty in the banking sector, rising interest rates, and a potential debt crisis in the US. With investors unsure of what’s next, many fear a stock market crash.
As with all emotional sell-offs, there are likely to be some fantastic companies now trading at a discount. So, do Lloyds shares (LSE:LLOY) fall into this category?
Volatility in the sector
The financial sector has continued to see volatility this week. With interest rates rising globally, and threat of a default in US debt, investors in all sizes of financial institutions have been incredibly nervous. Companies with larger cash reserves and diversified operations can be a relatively safe haven in such times. However, the scale of recent uncertainty and fear has impacted almost all companies.
Lloyds is certainly a large financial institution. With 26m customers globally, the company offers a range of services. These include current/savings accounts, mortgages, corporate finance, insurance products, wealth management, pensions, and investment banking. Lloyds shares have underperformed the financial sector in the last year, growing 1.1% compared to the average of 9.6%.
What is the fair value of Lloyds shares?
Analysing the fair value of banks can be challenging with traditional metrics. However, these can be useful when comparing them against competitors. To calculate the fair value of Lloyds shares, it can be helpful to use the discounted cash flow calculation. This establishes a suitable share price based on the present day value of current and future earnings. Based on this calculation, the current price of 45p is 25% below fair value of 61p.
With a price-to-earnings (P/E) ratio of 5.3 times, Lloyds shares are slightly cheaper than the broader financial sector at 6.3 times. Based on forecast earnings, the company may have further growth ahead, with a fair P/E ratio of 6.1 times.
Analysts covering the company have strong agreement that the share price will grow more than 20% in the coming year. The average price target is 39.7% above the current price. This potentially suggests that the bank is in a stronger position than many, and has been unfairly punished as smaller banks show potential weaknesses.
Is risk well managed?
Unlike some smaller banks, Lloyds clearly prioritises risk management. Most liabilities in Lloyds are made up of relatively low-risk obligations, such as customer deposits. Only 1.6% of loans are considered risky.
One concern is the recent trend of insider selling. This is where the leadership team members sell more shares in the company than they buy. This can be normal during economic downturns, but can also suggest low confidence. However, with a buyback of Lloyds shares announced earlier in the year, this seems to be unrelated.
Will I buy Lloyds shares?
With recent events in the financial sector, I expect regulation to increase. This could limit profits, making banks a less compelling investment. Systemically important banks such as Lloyds are likely to have the weight to influence the next chapter of regulation. However, I expect profits could lag those in previous years for some time.
I consider Lloyds shares to be a potentially lucrative long-term investment. However, with so much uncertainty ahead for banks, I see investments in other sectors yielding better returns. I won’t be buying Lloyds shares for my portfolio.
