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The Lloyds share price: is it what my portfolio needs?

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I’ve been looking for cheap UK shares to add to my portfolio. One investment that stands out is the Lloyds (LSE: LLOY) share price. 

Shares in this banking giant look cheap. They’re currently changing hands at around 34p. That’s compared to the 58p level recorded towards the end of January last year. 

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However, just because a share looks cheap compared to its history doesn’t guarantee positive future performance.

Attractive qualities of the Lloyds share price

There are a couple of reasons I like Lloyds compared to other UK banks. For a start, the banking group is highly profitable. For the nine months to the end of September, the group reported a return on tangible equity (RoTE) of 7.4%.

RoTE is a metric that’s quite commonly used in the banking sector. It looks at how much profit a business generates on every £1 of tangible or physical assets. Both of the group’s main peers, Barclays and Natwest, reported lower RoTE’s than Lloyds in the first nine months of last year. 

Lloyds also recorded an impressive capital ratio at the end of September last year. The group’s CET1 ratio, which measures how much available capital the bank has to absorb losses and lend to customers, was 15.2%. That was well above the level of 13.8% recorded at the beginning of 2020. 

Risks ahead 

These numbers suggest to me that Lloyds is more profitable than its peers. They also imply the bank’s balance sheet is healthy. Unfortunately, this doesn’t guarantee the Lloyds share price will be a good investment. If the UK economy takes a turn for the worst, the lender’s profit margins could collapse, and rising losses would eat into its capital ratio.

Forecasters are warning that the economy is facing an uncertain few months due to the pandemic. Unemployment is rising, and there could be hundreds of thousands of job losses in the hospitality sector over the next few months as lockdowns continue.

As such, I think Lloyds’ historical profitability figures should only be used as a rough example. They’re certainly no guide to future performance, either in the short or long term. 

Nevertheless, as a way to play the economic recovery after the pandemic, the Lloyds share price may offer opportunity, in my opinion. 

If the pandemic starts to recede over the summer, as some analysts suggest, the rebuilding process can begin. When it does, the group may increase lending, which would lead to increased profits.

A rise in business activity would also improve profitability. Many of the bank’s business customers pay for services based on the number of transactions. An increase in transaction volume would, therefore, lead to an increase in revenues. 

So, as a way to invest in the UK economic recovery, I think the Lloyds share price is worth considering as part of a well-diversified portfolio. Still, as noted above, there’s no guarantee the economy will ever recover, and that’s something I need to keep in mind.

But Lloyds has a strong balance sheet at this point, which should allow it to weather the storm, although additional losses might put pressure on the lender’s capital reserves. That’s something I’ll keep an eye on going forward. 

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Lloyds Banking Group and Barclays. 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.

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