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It’s been a rewarding 12 months for bank equity shareholders Lloyds (LSE: LLOY). Not only has Lloyds’ share price increased by 22%. FTSE 100 paid a dividend of 5.5 %.
However, in five years, the share has fallen by 13%. In the long run, well… Lloyds shareholders may not mind being reminded of the value destruction that has been going on since the millennium, when Lloyds shares changed hands for more than £3 each.
A cheap looking estimate
Still, even though it’s been a few rocky decades, the current price looks cheap on some metrics.
A price-to-earnings ratio of less than eight looks like a viable deal, in my opinion. For banking stocks, the most common valuation metric is price-to-book. Again, Lloyds shares look cheap.
With a large national loan book, a portfolio of well-known brands, and a strong recent record of profits, there is an argument that Lloyds’ share price should be higher than it is.
I think that may be true. However, I see risk – and poor risk management has hurt Lloyds badly in the past.
Here are two things that keep me from buying a bank stock right now despite the potential value on offer.
A review of motor vehicle finance commissions adds to the risks
The FCA has been conducting a review of commissions historically charged in the car finance industry.
In the first nine months of this year, Lloyds saw maintenance costs of £124m in this regard. That’s not a small amount, but it’s quite manageable for Lloyds.
Since the third quarter review in September, however, another court ruling has suggested that banks including Lloyds may face much higher costs in relation to the review than previously expected.
To some extent, we have been here before with British banks and the mis-selling of PPI (payment protection insurance). At the moment, there is no specific reason to expect that the average car finance commission repair cost will be anything as high as it was with PPI.
But we don’t know what the final costs will be – and if the court’s decision is upheld on appeal, that could mean costs could be much higher than previously expected.
That would be bad for the dark horse bank’s earnings – and helps explain why Lloyds’ share price has fallen 15% in less than a month.
Real estate market issues
How is the property market – and what could happen next?
That is a question that is rarely far from the minds of some Lloyds shareholders, given the bank’s exposure to the sector through its large mortgage book.
Profits and book value both depend on the book’s valuation assumptions being correct. If some are revised downwards, due to falling house prices or rising mortgages (or both), the apparent bargain presented by Lloyds’ current share price may be less than it first appears.
Meanwhile, the property market continues to perform well despite high interest rates. But if that changes for the worse, I see a risk in Lloyds’ investment case.
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