Many UK stocks have suffered significant declines over the past 12 months. Nowhere is this more apparent than in the financial sector. Equities such as Barclays (LSE: BARC) and Lloyds (LSE: LLOY) shares have severely underperformed the rest of the market.
However, I think this could be an excellent opportunity for long-term investors. Indeed, while these businesses might have to grapple with some challenges in the short term, in the long run, I believe their size and competitive advantages will help drive growth.
Here at the Motley Fool, we are long-term investors. That means we concentrate on a company’s underlying fundamentals, rather than letting short-term market movements drive our decisions. We also try to take advantage of the market’s short-term outlook.
I think this is something both Barclays and Lloyds shares are suffering from right now. In my opinion, investors are spending too much time concentrating on the risks these businesses face, rather than their opportunities.
This prevailing attitude has sent shares in both banking groups down to levels not seen since the financial crisis. Even though the stocks have recovered in the past few weeks, they’re still trading at deeply-discounted valuations.
Lloyds shares are cheap
Right now, Barclays shares are trading at a price-to-book (P/B) ratio of around 0.3. Lloyds shares are trading at a P/B of approximately 0.40. This might have been acceptable at the beginning of the pandemic as both businesses were reporting losses. Generally, if a company is losing money, that implies it’s shrinking.
Therefore, it doesn’t make sense to pay the book value or more for the equity. As such, at the beginning of the pandemic, a P/B ratio of less than one for both organisations would have been acceptable.
However, over the past 12 months, both Barclays and Lloyds have shown that the pandemic’s impact on their operations has been relatively limited. Both lenders reported significant losses in the first half of 2020.
But by the third quarter, the lenders had moved back into the black. Lloyds reported a pre-tax profit of £1bn in the third quarter. Barclays reported a net profit of £611m. Neither company has registered fourth-quarter results yet, but I believe it’s highly likely both groups will report a profit for the period.
On that basis, I think the shares look cheap from a valuation perspective. If Barclays and Lloyds shares returned to a P/B of 1, that would produce a return of more than 100% on the current share price.
What’s more, in the past few weeks, regulators changed their stance on bank dividends. They’re now allowing lenders to resume dividend payouts at an appropriate level. This suggests Barclays and Lloyds shares will become income investments once again in 2021.
Both have plenty of capital to cover any additional losses as well as pay shareholders a steady dividend. That’s another reason why I think the companies could be profitable acquisitions at current levels.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Barclays 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.