Lloyds’ share price looks like a FTSE 100 bargain! What’s the catch?

Lloyds’ share price trades on a rock-bottom P/E ratio and carries a huge dividend yield. Is it a steal at current prices, or a potential investor trap?

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Lloyds Banking Group’s (LSE:LLOY) share price has rocketed during the past two months. Yet at current prices of 50.7p per share the FTSE 100 bank still looks dirt cheap across a variety of metrics.

Its forward price-to-earnings (P/E) ratio stands at 7.9 times. This is comfortably below the Footsie average of 10.5 times. Meanwhile, the 6.2% dividend yield on Lloyds shares sails past the index average of 3.7%.

Finally, the bank’s price-to-book (P/B) ratio comes in at 0.7, indicating it’s trading at a discount to the value of its assets (minus its liabilities).

So why on earth is Lloyds’ share price so cheap? Let’s take a look.

Why I like Lloyds shares

There’s no doubt Lloyds has some potent weapons in its arsenal. As a major player in the UK mortgage market, it stands to gain massively from the recovery in Britain’s housing market.

Recent data suggests the turnaround is already in full flow, with the Royal Institute of Chartered Surveyors (RICS) this week predicting an upturn in home prices in the next year.

Lloyds also has significant brand power that helps reduce the threat from rapidly expanding challenger and digital banks. The massive investment it’s making in technology may also help win business in this new digital age.

The bank now has 21.5m digitally-active users, up almost a fifth since 2021.

Huge threats

Yet the Black Horse Bank also faces significant dangers in the near term and beyond. This in turn explains its rock-bottom valuation. And it’s making me consider whether buying Lloyds shares are too risky despite their cheapness.

A fresh surge in loan impairments is one significant danger to the bank’s bottom line. Bad loan charges cooled sharply in 2023, to £303m from £1.5bn a year before. But credit impairments are back on the rise and could remain problematic as long as the UK economy struggles.

The Bank of England (BOE) says that “lenders reported that default rates for total unsecured lending increased in quarter one” and added “they were expected to increase in quarter two”. It also said that rising defaults on secured loans were also predicted to continue.

The threat of impairments has increased further following latest inflation data from the US this week. It suggests that the BoE might also keep interest rates higher for longer, maintaining the strain on borrowers’ finances.

The City now puts the chances of a May rate reduction at below 10%. And predictions of cuts as far out as August are also receding.

The verdict

The trouble for Lloyds is that the UK’s economy is tipped to remain weak for the foreseeable future. It’s a scenario that could keep revenues growth under the cosh — and especially if interest rates do begin falling later in 2024 — as well as cause impairments to keep streaming in.

In fact, major structural problems (like labour shortages, low productivity and fresh trade barriers) mean Britain’s economy could splutter for years to come.

This is why, on balance, I’d rather find other cheap UK shares to buy 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 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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