Lloyds (LSE: LLOY) shares are down 8% year-to-date. That isn’t unusual for this bank stock, as it has fallen by over 7% on average each year for the last five years.
I thought the high street bank’s shares looked cheap after losing half their value at the start of the pandemic. But many other stocks were also ‘on sale’ at the time and I invested elsewhere.
In hindsight, maybe that was a mistake as Lloyds shares have nearly doubled since their 2020 lows. I could have made significant capital gains and generated income once the dividends were fully reinstated in 2021.
But now the UK economy is in a recession, Lloyds shares are once again looking incredibly cheap. At least on paper. Should I buy this time around?
The stock carries a forward P/E ratio of 6.4. That’s a low valuation. In fact, it correlates to a prospective dividend yield of over 5%. That’s higher than the FTSE 100 average.
Plus, the dividend is covered by around three times earnings. That cover is significantly higher than it’s been for most of the past five years. The stock’s price-to-book ratio is 0.62, which means (again, on paper) that the stock might be significantly undervalued.
On most metrics, Lloyds shares are incredibly cheap. Why?
Dire economic backdrop
Well, Lloyds is almost a pure UK banking play, with huge exposure to domestic consumer spending and the British housing market. As such, the bank is often seen as a proxy for the UK economy itself.
And it’s no secret that the UK economy is in the doldrums right now. In fact, the UK is facing its longest recession since records began, according to the Bank of England. And house prices are set to fall over the next couple of years too.
This dreadful economic outlook means Lloyds could see a higher rate of loan defaults. This would eat into its earnings and could result in the dividend being cut rather than increased.
After a decade of unusually low interest rates, the current environment of rising interest rates should be a massive boon for the bank (and stock). Higher rates mean banks can generate larger spreads between borrowing and lending rates. This typically leads to higher profits.
Yet this is entirely overshadowed by the dire state of the domestic economy. Until a clearer economic picture emerges, this bank stock could stay grounded.
Am I buying?
It’s not all doom and gloom, at least within the company itself. Just today, for example, it was announced that Lloyds has hired a new chief operating officer. He’ll help CEO Charlie Nunn deliver his strategy of digitising the high street operation.
This will see the company spend £1bn over the next three years to overhaul its technology infrastructure and self-service capabilities. The group will also focus on expanding its wealth management operations.
These moves are entirely sensible. However, I don’t see any longer-term structural growth for Lloyds due to its already high market share in core banking areas.
All in all, I think there are more attractive income opportunities elsewhere for me right now.
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Ben McPoland has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group Plc. 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.