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Metro Bank shares are up on Lloyds Bank takeover rumours. Here’s what I’d do now

The last time I covered Metro Bank (LSE: MTRO) in mid-May, the shares were changing hands for a little over 500p. At the time, I noticed hedge funds were shorting the stock heavily (which is never a good sign). For this reason, I said MTRO was “definitely a stock to avoid.” In hindsight, that was a good call. Since that article, the shares have fallen as low as 155p.

However, in recent weeks, Metro Bank’s share price has rebounded significantly on the back of talk Lloyds Bank could be interested in a takeover. Last week, the stock rose as high as 285p, although it has since fallen back to the 220p mark. So, what’s the best move now? Are Metro Bank shares worth buying, or should the stock be avoided?

Risky strategy

Personally, I think buying Metro Bank shares now is a risky strategy. There are a number of reasons why. For starters, the Lloyds takeover talk is just rumour at this stage, with no guarantee it will happen.

Of course, Lloyds could pick up Metro Bank very cheaply right now, given the challenger bank’s low enterprise value. But would it want to? I’m not so sure. Given that banking is becoming increasingly digital, I think that Lloyds would be better off acquiring a top-class FinTech company.

Buying a stock on the hope it may get taken over is generally not a sensible investment strategy, especially if the company has underlying problems.

Profit slump

Speaking of problems, Metro Bank appears to have quite a few of them right now. For example, third-quarter results, issued on 23 October, showed a 71% drop in underlying profit before tax for the first nine months of the year. There was also a 81% drop in underlying earnings per share. Ouch.

Furthermore, net interest margin – a measure of a lender’s profitability – for the nine-month period fell to 1.58% from 1.82% last year. In addition, the group said it was “further evaluating its future plans to balance growth, profitability and capital efficiency.” Clearly, Metro has issues to work through.

Short interest

Finally, the third reason I believe MTRO shares are a risky proposition right now is that short interest remains very high. According to shorttracker.co.uk, Metro Bank is currently the third most-shorted stock on the London Stock Exchange, with 10.2% of its shares being shorted.

This tells us hedge funds don’t like the stock and expect it to keep falling. Given the shorting success they’ve had with the likes of Carillion, Debenhams, and Thomas Cook recently, this alone is a pretty good reason to give the stock a wide berth, in my view.

All things considered, I think Metro Bank is a stock to be avoided right now. To my mind, there are much better stocks to buy. 

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Edward Sheldon owns shares in Lloyds Banking Group. The Motley Fool UK has recommended 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.