The past five years have not been easy ones for the economy overall, including banks. Still, banks like Lloyds (LSE: LLOY) remain hugely profitable. Despite that, Lloyds shares have lost almost 30% of their value over the past five years.
In the long term, I expect demand for financial services to stay robust – and Lloyds is one of the biggest players. So, ought I to take advantage of the beaten-down share price to pick up some Lloyds shares for my portfolio?
The investment case for Lloyds
Whatever has happened to the share price over recent years, it is worth remembering that Lloyds has a lot going for it.
Banking remains in high demand and I expect it always will. Although there have been challenges from the likes of fintechs, established banks understand their market well. Indeed, they have been able to use the growth of digital services to reach new customers themselves.
Lloyds has a leading position in the UK and, unlike some rivals such as Barclays and HSBC, it is mostly domestically focussed. That gives it strength in a sizeable market, with fewer overseas distractions. The bank is the country’s biggest mortgage lender, with a loan book of over £450bn at the end of last year. It has a well-known collection of brands, including Halifax and Bank of Scotland.
All of this translates into significant profit potential. Last year, the bank reported post-tax profit of £5.6bn. That means it currently trades on a price-to-earnings ratio beneath seven.
The bear case
But if Lloyds has so much going for it and is throwing off billions of pounds annually in profits, why has its share price been sinking over the long term?
The 2008 financial crisis burned a lot of British bank shareholders badly. Lloyds shares have never got back to their former share price and today’s dividend remains far below what it was back then.
British banks are in better shape now than they were going into that crisis, with today’s capital requirements reflecting some of the lessons learned back then. But as recent banking problems in the US and Switzerland have shown, capital requirements on their own may not be enough to stop a crisis if customers start to lose confidence in a bank.
The falling Lloyds share price reflects the risks facing banks, in my opinion. A weak economy could lead to loan defaults rising, hurting profits. But if that does not come to pass, or lasts only a short time, today’s share price does seem cheap.
Should I buy Lloyds shares?
Still, although the current price may ultimately turn out to be a bargain, I do not plan to buy.
I think the default risk remains considerable. Banks can try to control their loan book quality, but they are powerless to affect the overall direction of the economy. If it does badly, banks usually also suffer.
If the economy picks up and the risks to Lloyds reduce, I may not be able to buy its shares as cheaply as now. But I am comfortable with that opportunity cost, as the current risks in the banking sector do not sit comfortably with me.
The post Lloyds shares have fallen 29% in five years. Time to buy? appeared first on The Motley Fool UK.
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HSBC Holdings is an advertising partner of The Ascent, a Motley Fool company. C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays Plc, HSBC Holdings, and Lloyds Banking Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.