Lloyds (LSE: LLOY) shares have plunged over the past few weeks. The sell-off only accelerated after regulators in the UK asked the bank and its peers to suspend dividend payments for the foreseeable future.
While this decision is disappointing for income investors, it seems to be the right one. Paying out billions of pounds in dividends at a time when thousands of companies across the UK are scrambling for cash does not seem sensible.
What’s more, eliminating the dividend gives Lloyds more financial firepower. This should have a positive impact on Lloyds shares in the long term.
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Policymakers act
Unlike the last crisis, banks are much better prepared to weather the storm this time around. After 10 years of selling off non-core assets and building up financial reserves, banks are much stronger than they were 10 years ago.
Also, policymakers have acted with lightning speed to free up capital for the industry. Following these actions, most analysts believe there is unlikely to be a full-blown banking crisis any time soon.
Lloyds shares are undervalued
This suggests that now could be an excellent time to buy Lloyds shares. While the bank’s dividend has been cut, the demand for borrowing has exploded.
Meanwhile, the Bank of England’s decision to cut interest rates to a record low has reduced Lloyds’ cost of capital. That means it costs the bank less to borrow the money it then lends out to customers.
On top of these favourable tailwinds, after recent declines, Lloyds shares are now trading at one of the lowest valuations in the past decade. The stock is trading at a price-to-book (P/B) value of just 0.4. It is also dealing at a price-to-earnings (P/E) multiple of only 4.6.
While it is impossible to tell what the future holds for the global economy right now, these metrics suggest that Lloyds shares currently offer a margin of safety. The bank’s earnings might take a hit this year if it has to grant a lot of debt payment holidays to customers, but business should return to normal in 2021.
When it does, the metrics above suggest Lloyds shares could double from current levels.
Not for the faint-hearted
Having said all of the above, Lloyds shares are not an investment for the faint-hearted.
While the stock does look cheap at current levels, there’s no telling when the current economic situation will resolve itself. Most analysts and economists believe the economy will snap back next year. However, that’s the best-case scenario. We could also be at the start of a multi-year slowdown.
With this being the case, if you are willing to deal with volatility, now could be a good time for long-term investors to buy Lloyds shares. If you are looking for a more stable and predictable income investment, there could be better opportunities elsewhere.
