Stock market

Is Lloyds’ cheap share price a dangerous trap for investors?

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Investors are piling up. FTSE 100 And FTSE 250 Shares as part of a broader search for bargain stocks in recent days. The banking giant Lloyd’s (LSE:LLOY) is a UK blue-chip share whose share price has attracted a lot of attention.

Talk that British shares are undervalued has been circulating for years. Analysts in the City believe sentiment towards London-based companies has shifted to their best value by investors.

Many FTSE 100 stocks trade at rock-bottom price-to-earnings (P/E) ratios and also have very high dividend yields. But some stock market steals are not what they may appear at first glance. Many of these carry high risks for investors, which is reflected in their low valuations.

A healthy number

For example, take Lloyds shares. On the face of it, there’s a lot to like here.

Well, city analysts expect annual revenue to decline by 14% in 2024. But returns of 17% and 16% are indicated in 2025 and 2026 respectively as the UK economy picks up.

The bank also trades on an expected P/E ratio of just eight times for this year.

What’s more, Black Horse Bank – which has long been a solid source of passive income – is tipped to maintain rising dividends over the period.

As a result, the dividend yield on Lloyds shares rises above 7% over the next few years. And the payout forecast looks pretty strong too. As shown in the table below, the predicted profit is well covered by the expected income.

The year Dividend yield Dividend cover
2024 6.1% 2 times
2025 6.7% 2.2 times
2026 7.5% 2.3 times

A fantastic deal?

Bear in mind that the average forward multiple for FTSE 100 shares is 10.5 times, while the average dividend yield sits at 3.6%.

Such high street banks are seen as a safe choice for many investors. Like most stocks, they experience some volatility when economic conditions are bad. But the regular income they get through loan interest, product charges, and policy premiums can still make them profitable investments.

… or a terrible trap?

As an investor, I need to know if the risks of owning Lloyds outweigh these features. And on balance I do. In fact, I believe the bank fully deserves its low price.

As the chart below shows, Lloyds’ share price continues to struggle for traction. In fact, it has declined by 35% over the past decade, and it is difficult to see it breaking out of this long-term downward trend.

One problem is that the outlook for the UK economy is quite complicated. This suggests that Lloyds may face challenges in managing revenue growth as well as dealing with a steady stream of loan defaults.

Last week, the Organization for Economic Co-operation and Development cut its growth forecast for the UK for the next two years. Gross domestic product is now expected to grow by just 0.4% in 2024 and 1% in 2025 as interest rates ease due to inflationary pressures.

It follows a similar cut by the International Monetary Fund in recent weeks, dimming hopes for a bounceback in Lloyds profits next year. The bank is already facing the challenge of growing revenue as net interest margins (NIMs) are shrinking and competition in the banking sector is increasing.

As I say, the FTSE 100 is full of cheap-looking shares at the moment. But Lloyds is not what I would buy for my portfolio.

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