Buying Lloyds (LSE: LLOY) could be viewed as a risky move. After all, it is on the cusp of moving into full private ownership for the first time in almost a decade, with the government’s stake in the bank now being less than 5%. Furthermore, it has a significant exposure to the UK economy after its acquisition of HBOS. With Brexit talks set to start shortly, the UK economy could endure a challenging period. As such, many investors may see Lloyds as a stock to avoid at the present time.
While Brexit has not yet had a clearly negative impact on the UK economy, it seems likely to cause a slowdown to some degree in 2017. A weaker pound brought on by fears surrounding the UK’s economic future is starting to push inflation higher. In time, this could even surpass the pace of wage growth, which would squeeze real-terms consumer disposable incomes. As a consequence, the affordability of credit may fall and people may find their current debts more difficult to service and repay.
Lloyds is clearly a major player on the UK banking scene. Its acquisition of HBOS cemented its place as a UK-focused bank. Therefore, it is likely to be hit relatively hard by a deterioration in the performance of the UK economy. This could cause its profitability and share price performance to become volatile and potentially even negative over the short run.
Change of ownership
The sale of the government’s stake in Lloyds has been progressing at a modest pace for a number of months. It looks set to be returned to private ownership (as opposed to being part-owned by taxpayers) as soon as this year. While this could indicate a return to health for Lloyds, it also means that the bank may face a period of uncertainty. After all, whenever a major shareholder sells its stake, it can mean a change in strategy and a change in the long-term prospects for the business.
How the market will react to the completed sale of the government’s stake is a known unknown. It could cause investors to seek a wider margin of safety when valuing Lloyds, which may act as a drag on its share price performance in the short run.
Despite these risks, the reality is that Lloyds is exceptionally cheap at the present time. Therefore, even if Brexit has a negative impact on trading conditions for UK-focused banks and the market reacts negatively to the sale of the government’s stake, the bank’s share price may perform relatively well. For example, Lloyds trades on a price-to-earnings (P/E) ratio of 9.5, which indicates that it has a wide margin of safety.
Certainly, its short-term outlook is uncertain. However, Brexit may not hold back the wider sector and the government’s share sale could be viewed as a sign the bank has returned to full health. Therefore, Lloyds does not appear to be a relatively risky stock – especially when its wide margin of safety is factored-in.
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Peter Stephens owns shares of Lloyds Banking Group. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.