Is Lloyds’ cheap share price a dangerous investor trap?

Royston Wild explains why Lloyds’ rock-bottom share price may reflect its status as a high-risk FTSE 100 company.

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Investors have been piling into FTSE 100 and FTSE 250 shares in recent days as part of a wider hunt for bargain stocks. Banking giant Lloyds (LSE:LLOY) is one UK blue-chip share whose share price has attracted lots of fresh attention.

Talk that British shares are greatly undervalued has been doing the rounds for years. City analysts believe sentiment towards London-based companies may have turned as investors wise up to their excellent value.

Many FTSE 100 stocks trade on rock-bottom price-to-earnings (P/E) ratios and also carry huge dividend yields. But some aren’t the stock market steals that they may appear at first glance. Plenty of them pose big risks to investors, which in turn are reflected in their low valuations.

Healthy numbers

Take Lloyds shares, for instance. On the face of it there’s a lot to like here.

Okay, City analysts expect earnings to fall 14% year on year in 2024. But profits are tipped to rebound 17% and 16% in 2025 and 2026 respectively as the UK economy accelerates.

The bank also trades on a prospective P/E ratio of just eight times for this year.

What’s more, the Black Horse Bank — which has long been a solid source of passive income — is tipped to keep growing dividends through this period.

As a consequence, the dividend yield on Lloyds shares moves above 7% over the next few years. And payout forecasts look pretty robust as well; as shown in the table below, predicted dividends are well covered by expected earnings.

YearDividend yieldDividend cover
 2024 6.1% 2 times
 2025 6.7% 2.2 times
 2026 7.5% 2.3 times

A brilliant bargain?

Bear in mind that the average forward multiple for FTSE 100 shares is 10.5 times, while the average dividend yield sits at 3.6%.

High street banks like these are seen as a safe choice for many investors. Like most stocks, they experience some turbulence when economic conditions worsen. But the regular income they receive through loan interest, product charges, and policy premiums can still make them lucrative investments.

… or a terrible trap?

As an investor, I need to weigh up whether the risks of owning Lloyds outweigh these qualities. And on balance I do. In fact, I believe the bank fully merits its low valuation.

As the chart below shows, Lloyds’ share price continues to struggle for traction. In fact, it’s down 35% over the past decade, and it’s tough to see it breaking out of this long-term downtrend.

One problem is that the outlook for the UK economy remains pretty murky. This suggests that Lloyds may face challenges in increasing revenues while also dealing with a consistent stream of loan impairments.

Last week, the Organisation for Economic Co-operation and Development slashed its growth forecasts for Britain for the next two years. Gross domestic product is now expected to advance just 0.4% in 2024 and 1% in 2025 as inflationary pressures temper interest rate cuts.

This follows similar downgrades by the International Monetary Fund in recent weeks, darkening hopes of a bounceback in Lloyds’ profits next year. The bank already faces a challenge to grow earnings as net interest margins (NIMs) retreat and competition heats up in the banking sector.

As I say, the FTSE 100 is jam-packed with cheap-looking shares right now. But Lloyds isn’t one I’d buy for my portfolio.

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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