Why I think Lloyds Bank shares look cheap
The almost 60% plunge in the share price this year has thrown up some interesting valuation indicators. Near 26p now, the price-to-tangible book value is around 0.5. And earnings have collapsed this year putting the earnings multiple above 22. For a cyclical share like Lloyds, a high multiple alongside a collapsed share price is positive. And the fact the shareholder dividend has been suspended adds further weight to the bull case.
Around 97% of its revenue comes from the UK. And the bank is wedded to the fortunes of the UK economy perhaps more closely than any other cyclical. It’s the anticipation of a downturn that’s brought the stock to its knees as much as weakness in the trading figures. And it will be the anticipation of economic recovery that will push the stock higher. Indeed, banks can be among the prime movers as far as cyclicals are concerned when the economic clouds part to reveal the first chinks of light.
But there’s a lot weighing on sentiment right now. However, things could change quickly. For example, if the UK finally agrees a free trade agreement with the EU we could see shares such as Lloyds respond well to the news. And overriding that, we have worries about the coronavirus pandemic and how it will continue to affect the economy. The arrival of a vaccine could be sudden, and the outlook could change almost overnight.
Downside risks remain
However, those things could work for the bear too. If a free trade agreement doesn’t arrive, we could see a reaction in the stock market to the downside – at least initially. And if a second wave of the pandemic bubbles up to the point that it forces further lockdowns, there will likely be downward pressure on shares such as Lloyds. And the move further down will be justified if profits take a further hit.
On top of all those probabilities, it’s worth remembering that banks tend to be more profitable in high-interest-rate environments. But higher interest rates seem like an impossible dream right now and could be decades away if they arrive at all.
Looking back at the way Lloyds behaved following the last crisis more than 10 years ago, it’s clear the up-move was short and sweet. It took just 18 months for the stock to move from below 30p to above 70p. Then, the shares moved essentially sideways for years with no further upside progress. Even though earnings continued to rise, the share price had a ceiling and the valuation simply contracted.
However, at the higher levels above 70p, there was plenty of downside risk. It came home to bite this year. So, I’d never make Lloyds a long-term hold. In that sense, it’s more of a value trap than anything else. But if you are looking for a quick move upwards, Lloyds could be a once-in-a-decade opportunity – but even now, it’s risky.
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You probably saw this announcement in the news. But we bet you’ve never heard of the company which we believe could profit.
Kevin Godbold has no position in any share mentioned. 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.