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Lloyds share price down 5%! Is the bank a bargain buy or a value trap?

When a share price drops substantially, people understandably get excited. They hear about investing legends, like Warren Buffett, sweeping up big stakes in companies when the stock price has tumbled, and try to use the same strategy.

But without a full understanding of why the share price has dropped, I think this is a very risky gamble. If you were seeking a bargain and bought shares in Sirius Minerals on 7 August, after it dropped 38% in a week, your investment would have now decreased by 66%.

Let’s take a quick look at Lloyds (LSE: LLOY) and see if this is something that value investors should think about adding to their portfolios.

Keeping it local

I’ve been anxious about Lloyds for a while now. In September, I mentioned two other financial stocks I preferred. My concerns then stemmed from the lack of diversity from the Lloyds group. Its earnings are mostly domestic, and I thought the bank was more susceptible to problems arising from the UK’s withdrawal from the EU than internationally diversified rival, HSBC. That’s without mentioning what might happen to interest rates post-Brexit.

At the time, the bank was also managing a setback from larger-than-anticipated payments for PPI claims, which was another red flag for me. Lloyds estimated these payments to be between £1.6bn to £1.8bn. Has anything changed in the past couple of months to change my mind?

With a prospective yield of 5.5%, the Lloyds dividend remains strong – albeit lower than HSBC’s – and the price-to-earnings ratio at the bank is now an appealing 10. 

Part of the reason for the recent slump is due to disappointing results issued at the end of October. Profits were hit by the £1.8bn of PPI claims in the third quarter, as the figure is at the top end of its earlier issued estimate. Revenue also decreased by 6% to £4.2bn, which was short of analysts’ expectations. This is disheartening news, as the revenue figure was unaffected by the PPI claims.

The good news was that the bank beat predictions on its costs.

What next?

The banking sector is a tough landscape at the moment. With increasing competition from new entrants and disruptors stepping into the market, coupled with low interest rates and a turbulent political environment, it is unstandable why a lot of banking stocks have taken a battering over the past year or two. 

A lot of these elements are out of Lloyds’ control. Political uncertainty, for example, means that business confidence is still low.

It is hard to see much of a silver lining in the Q3 results. But there is hope for Lloyds. Along with the 3% reduction in operating costs, the bank has seen growth in its SME segment, with motor finance up 8%. 

With the odds of a no-deal Brexit looking less likely than the last time I evaluated the stock, buying shares in the bank seems slightly more appealing. But given the choice between Lloyds and HSBC, I would still chose the latter, given its diversity, size, and larger dividend.

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T Sligo has no position in any of the shares mentioned. The Motley Fool UK has recommended HSBC Holdings and Lloyds Banking Group. 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.