Still below 46p. Are Lloyds shares the bargain of the decade?

As a long-time holder of Lloyds (LSE:LLOY) shares, I’m starting to get frustrated. They haven’t been over 55p since the start of 2020. In fact, they were higher on the day that the Brexit referendum result was announced, a decision that disappointed financial markets.

I’m beginning to wonder whether there’s a major issue with the bank. I’ve therefore looked at McKinsey’s latest annual review of global banking to try and identify why the Lloyds share price is apparently stuck in the doldrums.

The expert view

According to the research, margins are a more important driver of growth than volume.

But Lloyds seems to be doing OK here. Its net interest margin is moving in the right direction. Although this is to be expected given that the Bank of England has increased the base rate 11 times in 17 months.

McKinsey found that the global banking system had a tier 1 capital ratio (a measure of solvency) of 14%-15%. It was 14.1% for Lloyds at the end of 2022.

They also calculated that the average return on equity (ROE) was 11.5%-12.5%. On this measure, the UK’s largest lender is well ahead. It’s expecting to achieve a return of 13% in both 2023 and 2024, rising to more than 15% by 2026.

Also, the bank’s ROE is higher than its cost of capital (the amount paid paid to finance its operations). Surprisingly, only half the world’s banks are in this position.

This all seems positive.

Areas of concern

But McKinsey’s report identified three issues that might explain why investors don’t appear to be falling over themselves to buy shares.

First, a bank’s primary location accounts for 68% of its valuation. Lloyds generates nearly all its revenue in this country. However, the UK economy is struggling with stubborn inflation and low growth.

Second, specialist banks trade at higher premiums than more traditional ones. For example, those operating financial exchanges attract valuations 4.5 times higher. On average, payments providers have a multiple of nine.

Finally, the most successful financial institutions are those with a cost-to-income ratio of 35%-45%. Lloyds’ is currently around 50%.

These factors could explain why the bank’s price-to-book ratio is currently 0.61. Only 50% of the world’s banks — which account for 70% of global market cap — have a ratio higher than one. Interestingly, they only account for 30% of assets.

So what does this all mean?

Final thoughts

I don’t think there’s anything fundamentally wrong with Lloyds. Its key performance metrics are broadly in line with industry averages.

The global banking sector has a price-to-earnings ratio of around 13. Lloyds’ is currently below seven. I interpret this as a sign that its shares are undervalued — something of a bargain, in fact — rather than an indicator of operational problems.

Instead, I think it’s primarily a victim of its exposure to the UK economy. Until growth returns to historical norms, its stock will struggle.

Investor confidence in the sector has also been affected this year by the collapse of three US banks. But I believe this to be an isolated problem.

Despite the issues identified above, the bank continues to pay a dividend that gives a yield above the FTSE 100 average. This helps relieve some of my frustration.

I’m therefore not going to sell my shares. But I’ll review my position later in the year.