Are cheap Lloyds shares now a no-brainer buy?

The Lloyds share price looks like excellent value at a current 44.4p. But is it really a brilliant stock to buy, or a classic investor trap?

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The Lloyds Banking Group (LSE:LLOY) share price has lost 4% of its value in 2023. And I think there’s a good chance it will continue to extend recent losses.

On paper though, the FTSE 100 bank looks tantalisingly cheap. And it’s attracting a lot of interest from bargain hunters (it’s consistently in and around the top 10 most-bought stocks with Hargreaves Lansdown clients).

Today, Lloyds shares trade on a forward price-to-earnings (P/E) ratio of 5.9 times. It also carries a market-beating, FTSE-beating 6.3% dividend yield for 2023.

So should I buy the stock for my own portfolio?

Double-edged sword

Banks are some of the most economically sensitive shares out there. And as the UK struggles with high inflation, the outlook for this domestically-focused business remains pretty challenging. This is why Lloyds shares carry such a low valuation.

Elevated levels of inflation are a double-edged sword for banks. As interest rates are hiked to curb price rises, the difference between what these firms charge borrowers and offer savers usually increases. This is known as the net interest margin (NIM).

The problem is that higher-than-usual inflation also has large direct and indirect problems for the likes of Lloyds. It limits consumer spending power in the short term. And as the Bank of England raises its borrowing benchmark in response, it gradually chokes off economic growth.

Bad omens

Signs of strain are already emerging at Lloyds. The bank is struggling to grow its loan book as people cut non-essential spending. It’s also witnessing a steady rise in credit impairments (these increased by an extra £662m in the first half of 2023).

Worryingly, economists are scaling up their inflationary expectations for the short term too. The OECD, for example, now expects consumer price inflation (CPI) to average 7.2% this year, the highest of any advanced economy and up from a prior estimate of 6.9%.

The body also hiked its 2024 forecast 0.1%, to 2.9%. Stubborn food inflation and rising oil prices suggest further adverse revisions could be made in the months ahead.

The verdict

High street banks have performed robustly so far despite the tough economic backcloth. This is because they have been reluctant to raise savings rates as quickly as loan costs as interest rates have risen.

This strategy saw Lloyds’ NIM rise to 3.18% in the first half from 2.77% a year earlier. And it helped drive pre-tax profit 23% higher, to £3.9bn.

However, banks’ overall ability to continue on this path looks limited. The Financial Conduct Authority (FCA) has vowed publicly to take banks to task if they continue. This creates huge doubts over how they will create profits in the short-to-medium term.

Lloyds has one major weapon in its favour, and that’s exceptional brand recognition. This is especially important when it comes to matters of money. And it could help it avoid a total washout as the economy struggles.

Yet I still believe the odds are stacked against the company. On top of those economic and regulatory pressures, the bank also has to see off the rising threat from digital and challenger banks.

The shares might be cheap. But I think investing in Lloyds is far too risky right now.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Hargreaves Lansdown Plc and Lloyds Banking Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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