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The uncomfortable reality about Lloyds Banking Group shares

Anxious young man biting his nails fingers

The uncomfortable reality about Lloyds Banking Group (LSE: LLOY) is I was right to be cautious about the stock in an article almost five years ago.

Nothing’s changed

That old scribbling had the headline, The uncomfortable truth about Lloyds Banking Group plc. And that’s similar to this article’s headline. But there’s a reason for that — nothing’s changed. I still think of Lloyds as an investor trap. It always seems to look attractive. But it can clamp shut and lock investors into a losing position like a Venus flytrap catches a bluebottle.

In the old article I said: “As Lloyds moves towards what looks like a ‘normal’ existence after the ructions of the financial crisis, investors seem attracted to the firm for its cheap-looking valuation.”

Lloyds continues to look cheap today. And the stock is still underperforming for its long-term shareholders. As far as I can see, the words ‘underperform’ and ‘Lloyds’ go together like a hand in a glove for the stock. And that’s why I’ve been banging on about it in multiple articles over several years. One day, I hope to be wrong, for the sake of all those holding Lloyds shares for the long term.

However, it hasn’t all been bad. Lloyds regularly moves up higher from its lows. So there have been some decent shorter-term investment opportunities. And I’m sure some nimble investors will have done well from those moves. But as a long-term stock commitment, I’m not impressed.

Why Lloyds probably isn’t as cheap as it looks

Today’s share price near 45p throws up a forward price-to-earnings (P/E) ratio just over seven for 2022. And the anticipated dividend yield is above 5%. Meanwhile, the price-to-tangible book value is about 0.8. So, on traditional valuation indicators, it’s hard to suggest that Lloyds looks expensive.

But what if earnings plunge in the years ahead? Banks like Lloyds have businesses that are about as cyclical as cyclical businesses can be. And that means plunging profits are a regular feature of the firm’s trading and financial record.

But the share price and shareholder dividend payments tend to cycle up and down as well. And that’s why I reckon the market rarely assigns Lloyds a high-looking valuation — the next profit plunge could always be just around the corner. So, a lower valuation helps to accommodate that possibility.

Right now, for example, City analysts have a consensus for earnings to decline by just over 20% in 2022. So, Lloyds deserves its low valuation because of the huge potential for volatility in the business model. And I’d restate my conclusion of nearly five years ago, “the only thing going for the stock right now is fragile share-price momentum and a fat, but in my view precarious, dividend.”

Of course, I could be wrong and Lloyds may soar off to new heights in the years ahead. The business tends to do well when the general economy is thriving. And there’s potential for the world and the UK to continue its recovery from the pandemic if the Omicron variant is conquered by vaccines and other treatments. On top of that, banking businesses can prosper in higher interest rate environments. And the base interest rate could begin creeping up soon. 

Nevertheless, I’ll be watching from the sidelines rather than owning Lloyds stock now.

The post The uncomfortable reality about Lloyds Banking Group shares appeared first on The Motley Fool UK.

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Kevin Godbold has no position in any of the shares 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.