If we’re talking about buying Lloyds Banking Group (LSE: LLOY) shares today, thinking they’re cheap must be a good enough reason, right?
Well, the share price does look very low, especially after the past few months of falls.
Quality counts
But on its own, no, I don’t think so. Remember what Berkshire Hathaway boss Warren Buffett said?
It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
Letter to shareholders, 1989.
While a nice cheap valuation is good, I see it as just a bonus. I mean, I’ve bought shares before that I thought were screamingly cheap. And then lost money on them.
The companies just were not wonderful, it turned out. But what three things might make me think Lloyds is?
Finances
First up, I want to see financial stability. When the economy is in a bad state, banks in particular can suffer. I don’t think any investor will forget the great bank crash of 2008 any time soon.
On that front, Lloyds has just released its scores for the Bank of England (BoE) stress tests for 2022. Those tests subject the bank’s balance sheet to a severe test of economic stress.
I won’t go into all the numbers. But Lloyds says it “comfortably passed” the test. And it doesn’t have to take any capital actions.
Financial stress could still be the biggest risk this year. But the BoE is happy, and I’d say that’s a good sign.
Essential
Next, I want to see essential goods or services. And I want a good protective moat with high barriers to entry. Have I squeezed two things into one here? Maybe, but I hope readers will forgive me.
The UK simply can’t work without the banks. And I reckon that makes the financial sector about the most essential there is today. Think food is more important? Without a financial system, how could it get from the fields to our plates?
The huge capitalisation of banks also makes them pretty safe from newcomers, I’d say. We saw the rise of challenger banks after the big crisis. But even though the big players were reeling, the new rivals still made few real inroads.
Cash cow
All this would be no good if a company didn’t generate cash for its owners. And Lloyds has a lengthy track record of paying out piles of the stuff.
Sure, it’s had its bad times, and there could be more of them. Any sign of bad debt problems could squeeze the cash a bit, especially as Lloyds has huge exposure to mortgages.
That could harm the dividend. And that, in turn, could scare off investors again and Lloyds shares could fall some more.
Wonderful
But despite the clear economic risks in 2023, I reckon Lloyds fits the Buffett criteria. I think it could be a wonderful long-term buy for investors who understand the risks.
And it really is a nice bonus to see Lloyds shares at what I think is a very cheap price.
