The past year has been a good one for shareholders in Lloyds (LSE: LLOY). During those 12 months, the Lloyds share price has soared 40%. And even after that rise, the black horse bank offers a juicy dividend yield of 4.9%.
But the thing is, despite growing by two-fifths, Lloyds shares still look cheap on some metrics. Should I buy?
Looking cheap… in some ways
One approach would be to look at the bank’s price-to-earnings (P/E) ratio. At 8, it looks cheap to me.
Passive income stocks: our picks
Do you like the idea of dividend income?
The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?
If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…
Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.
What’s more, today we’re giving away one of these stock picks, absolutely free!
But when it comes to valuing shares in banks, earnings are not necessarily the best measurement to use. One alternative many investors look at (often alongside the P/E ratio) is price-to-book (P/B) value.
For Lloyds, that ratio currently stands at around 0.8. A figure less than one basically indicates that a stock is selling for less than the firm’s assets are worth, meaning it is a potential bargain.
Valuing bank shares is never easy
Here is the thing, though: neither of these measurement tools is ideal, especially from a forward-looking perspective.
Why? Think about what happens to a bank when the economy contracts. Often, more people will default on loans. As the country’s largest mortgage lender, that is a risk for Lloyds.
In addition, house prices may fall. So, a bank can face a double whammy. Earnings can fall as more provisions need to be made for bad loans, while the book value can also fall simultaneously as homes are worth less than before.
That is not a problem specific to Lloyds. It is one that faces any bank. As with its peers, Lloyds could be adversely affected but there is a limited amount it can do to protect itself. In a serious property or banking downturn, few lenders are unaffected.
Since the 2008 financial crisis, Lloyds (alongside other banks) has tightened up its capital base. That gives it a bigger cushion against volatility. But sooner or later, I expect a serious economic setback and imagine that will hurt Lloyds’ results and also its share price.
I’m in no rush to invest
Until then, I think the shares could keep moving up. After all, they still look cheap today on a variety of valuation metrics. The bank is solidly profitable, has a large customer base and strong brands.
But my concern is that both the UK and global economy look weak. Things could get better from here, but there is no guarantee they will.
Once we seem to be more comfortably in a sustained upward part of the economic cycle, I would consider buying bank stocks, including Lloyds, for my portfolio. For now though, I continue to dislike the risks involved. So, although the share price looks cheap, I do not expect to be adding Lloyds to my portfolio in the foreseeable future.
