Lloyds (LSE: LLOY) is a massive banking company. It is the market leader in mortgage lending in the UK. As well as the Lloyds brand, the company owns famous names like Halifax and Bank of Scotland. But despite – or perhaps because of – that strong business position, the Lloyds share price has tumbled 16% so far this year. Over the past 12 months, the shares are down 8%.
So, is the banking giant now a bargain buy for my portfolio?
Growing risks
I think it is helpful to consider what is behind the fall. With a price-to-earnings (P/E) ratio of under six and a dividend yield of 4.7%, the bank shares now looks cheap. So, what has caused that?
Share valuation involves trying to understand what a business may be worth in future, rather than just today. The current picture at Lloyds indeed looks rosy, with its leading market position allowing it to make enormous post-tax profits of £5.8bn last year.
But looking ahead, things could get bumpy. A recession is on the cards before the year is out, according to the Bank of England. If that causes consumer loan default rates to rise or the housing market to fall, it could be bad news for Lloyds. Higher defaults would likely mean lower profits. Indeed, if the economic situation gets really bad, profits could fall a long way.
Lloyds share price valuation
That is why it can be hard to value Lloyds shares right now, in my opinion.
The bank could tolerate a shrinking economy and increased default rates up to a certain level while still making chunky profits. That is the benefit of having such a substantial profit base to begin with. But the risk is that, if the housing market really struggles, the bank’s profits could fall dramatically.
While the current P/E ratio may look cheap, it is based on historical earnings. If earnings fall, the valuation might not look so attractive. In the first quarter, Lloyds’ underlying profit fell 7% compared to the same quarter last year. Its basic profit after tax fell by 14%. One quarter is a short period of time, and I think it is important not to read too much into a single set of quarterly results. But the fall in profits was concerning to me. If that trend continues across the rest of the year, I think it could be bad news for the Lloyds share price.
My next move
Based on that, I do not see Lloyds as a bargain. On some metrics its shares look cheap. But uncertainty about the economic outlook and future profitability mean that the shares may not end actually being as cheap as they seem, for example, if the bank suffers a sustained fall in earnings.
I think the dividend yield is attractive and I also like the bank’s strong position in the UK banking market. I continue to hold the shares. But I do not see them as a bargain and am not planning to buy more for my portfolio right now.
