Investor warning: I’d listen to Warren Buffett before buying Lloyds shares

Lloyds shares look like a bargain, especially compared to their US counterparts. But Stephen Wright thinks there might be a reason for this.

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Even after a recent rally, shares in Lloyds Banking Group (LSE:LLOY) still look like a bargain. A price-to-book (P/B) ratio of 0.8 with a return on equity of 12% is an attractive valuation.

Despite this, I  think investors ought to be careful when considering buying the stock. And one of the key risks was pointed out last year by Warren Buffett.

A bargain?

Compared with some of its US counterparts, Lloyds shares look extremely cheap. The P/B ratio the stock trades at is lower than either Bank of America (1.1) or JP Morgan Chase (1.8).

It’s not as if the UK bank’s significantly less efficient. A 12% return on equity is between the 10% BofA achieved last year and the 17% JP Morgan managed with some unusual successes.

Unlike Lloyds, both those US banks combine their consumer lending with substantial investment banking operations. This should help when interest rates start to fall – whenever that is.

Right now though, Lloyds looks like a good example of a UK stock selling at a discount to its US peers. But there’s a serious risk investors looking at the stock should be aware of.

Buffett on banks

Until recently, Berkshire Hathaway owned substantial stakes in the major US banks. But since 2020, Buffett has been divesting of those investments. 

At last year’s shareholder meeting, he said one of the key reasons for this is the prospect of regulation. While there’s good reason for this in principle, how it works in practice is less certain.

The issue isn’t just that regulators might not act in the interest of shareholders. It’s that they might be incentivised to act in ways that are opposed to investor interests, even when they ought not to.

To a large extent, this means that the future earning power of the likes of JP Morgan is out of the company’s hands. This creates risk and I think it might be even more so with UK banks like Lloyds.

UK sentiment

In the UK, banking regulations are an intensely political subject. Since the 2008 crisis, sentiment towards banks from the public in general hasn’t been particularly warm.

Against this backdrop, Lloyds finds itself in a bit of an awkward position. With interest rates rising, the bank’s found itself reporting record profits at a time many are facing higher debt costs.

This has engendered speculation about a possible windfall tax on banks – which Positive Money suggests could raise between £5bn and £20bn. In an election year, this could be important.

The situation is complicated by the UK government’s ownership of NatWest, which arguably aligns its interests with those of investors. But once it disposes of this later this year, things get less clear.

Risks and rewards

I’m not saying buying Lloyds shares is a bad idea. The bank’s demonstrated it can thrive in a helpful environment and the longer interest rate cuts get delayed, the better things look.

In my view though, investors should be careful when looking at the stock and seeing that it trades at a lower multiple than its US counterparts. The discount might turn out to be justified.

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.

JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Bank of America is an advertising partner of The Ascent, a Motley Fool company. Stephen Wright has positions in Berkshire Hathaway. 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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