It has been a wild week for bank shares, especially in the US. While some UK banks have seen their share prices jump around, we have not seen anything like the swings witnessed across the pond.
Still, many British bank shares trade on seemingly cheap valuations. Take Lloyds (LSE: LLOY) as an example. Its shares have been selling for pennies not pounds apiece for years already.
But this is a banking giant. It owns a variety of well-known financial services brands and is the country’s biggest mortgage lender. Last year, although post-tax profits fell, they still came in at a whopping £5.6bn. Despite that, the shares yield 5% and trade on a price-to-earnings ratio of less than seven.
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Are they a bargain for me to add to my portfolio?
Possible bargain
In short, I think the answer may be yes. Lloyds shares have an attractive valuation, considering their P/E ratio. Often banks are valued by looking at their price to book ratio. At the moment, for Lloyds this ratio is around 0.7. That looks cheap to me.
But why do I think Lloyds shares are simply a possible bargain and not necessarily an actual bargain?
For now, it remains unclear what will happen to earnings and book values at UK banks in the years to come. A difficult economic period could lead more borrowers to default on their loans, for example. That could lead to a big drop in earnings at banks such as Lloyds.
Global picture
An additional risk that has come to the fore in the past several weeks is investor confidence. The huge run on Silicon Valley Bank in the US has shaken investors. Many are now running their slide rules over banks worldwide to understand how stable they are.
The risk I see is that banking relies heavily on confidence. Even a bank that is well capitalised and competently run can see its value plummet if investors lose confidence in the sector.
I view Lloyds as prudently run. Its risk management practices have been transformed since the financial crisis. Its pro forma common equity tier one capital ratio (a measurement of capital buffer) ended last year at 14.1%, in excess of its ongoing 12.5% target.
However, if the banking sector starts to encounter a serious fall in investor confidence, that could affect banks even if they have a strong capital buffer. For now, that risk looks like it has been averted, but I am not confident it has disappeared. I expect to see more volatility in the banking sector in coming weeks and months.
I’m not buying
For that reason, I am not buying any bank shares right now, including Lloyds. Indeed, having sold my Lloyds shares last year, I also sold my other bank shares in recent months and now have none in my portfolio.
If the risks recede, today’s Lloyds share price may yet seem like a bargain. The bank has considerable strengths and remains a moneymaking machine. But, for now, I will be avoiding it.
