7 Reasons NOT to Buy Lloyds Shares Today!

LLOYDS Shares - Introduction

Lloyds Banking Group, a major British financial institution and a constituent of the FTSE 100 index, has a robust capital position because of its attractive valuation and dividend yield, which are the qualities that appeal to all investors making it one of the most searched shares on most UK brokers platforms.

At the current share price of 54p, P/E ratio of 7.3 and the potential dividend yield of a great 6%. The Lloyds shares look cheap and inviting. However, is it worth buying shares in Lloyds today to benefit from this valuation opportunity?

I think it’s important to stop and reflect on the following seven risks of investing in Lloyds.

1. Long term impacts of the 2008 financial crisis.

The financial crisis of 2008 were dark times for the banking sector, causing banks to lose money. Lloyds was no exception and while some claim that the bank did not actually collapse or go bankrupt still, together with HBOS, the bank had to be bailed out by the UK Government which took a 43% stake in Lloyds as part of its bank rescue package by investing £20.3 billion in October 2008.

It’s important to note that this was just a month after the company’s disastrous £12bn acquisition of HBOS, causing its share price to drop, such that from the start of September 2008 until the year-end the shares in bank dropped by 56%.

Even recently, the shareholders who lost money following the acquisition of HBOS launched a court action against Lloyds, claiming they would not have voted through the deal if they had known the extent of its financial struggles.

In its 2017 results, the company reported its highest pre-tax profit since 2006. Yet shares were still down about 58% since the financial crisis.

Lloyd has recently fully privatized with the government selling all its shares in the bank with a total proceeds of £21.2 billion, which exceeded total investment by £900 million, reported as profit to government but this calculation is incomplete unless you include the cost of financing the investment which turns the £900 million gain into a £3.2 billion loss.

2. The UP we are waiting for.

Lloyds shares price, after reaching a high of nearly 67p per share in April, started falling and hasn’t stopped since. By August 2019, it fell to a shocking 27% from the April high, underachieving the FTSE 100 by around 22%.

Succeeding this decline, shares in Lloyds shares are now dealing at a forward P/E of 6.3 and a price-to-book ratio of 0.7, one of the lowest valuations placed on the stock in the past five years. Indeed, the five-year average forward P/E for the bank is around 8. Although quietened by dividend, the investors who have bought shares since 2015 are still waiting for the price rise.

The share price has fallen 21% since the turn of the year. And you’d be either very brave or reckless to predict any sort of imminent recovery.

3. Global market deceleration and Low-interest rates.

Germany, Europe`s largest economy looks as it is moving towards recession and the warnings are flashing around the rest of the world. Investors and traders are concerned principally about the `Inversion of the yield curve` which is a phenomenon where longer-term interest rates in the bond market fall below shorter-term interest rates and this is read as a sign of advancing recession.

A global recession together with Brexit uncertainty since the referendum in 2016 would cause lower earnings and the bank would be hit with higher loan default rates. In this situation, if the Bank of England lowers the base rate, Lloyds would have to lower the interest rate it charges its borrowers too.

4. Paying demanding dividends with low cash flow.

Ever since Lloyds pulled itself back from amidst the financial crisis, it’s been mounting its earnings per share steadily. The dividends are accumulating which provides with some compensation for share price loss. Although the dividends are covered around 1.7 times by earnings, which I see as safe enough in current times, an economic recession could easily result in another crush to banking profits and on the dividend.

The annual cash is by no means assured.

5. Lack of modern technology revolution (FinTech Threat)

The banking industry right now is completely overhauled by the new digital banks and advanced FinTech firms. If the traditional banks such as Lloyds are not careful of these new entrants, they could end up losing all customers. With new digital banks, customers feel more at ease as you can open an account online within minutes and access a digital card instantly instead of the visiting a branch, speaking to an advisor and waiting for a week for the debit card.

6. Low international exposure

Lloyds is a domestically-focused bank and the largest provider of mortgages in the UK so it’s greatly influenced by the UK economy. Brexit (the withdrawal of the UK from the European Union) which will presumably reduce the real per capita income in the UK adds major uncertainty making investors worry about post Brexit when the inflation dents consumption.

While UK growth emanated at 0.5% in the first quarter, the Bank of England (BoE) informed that the economy would flatline in the second quarter and dropped its forecast to zero from a previous estimate of 0.2%. An economic contraction as a result of Brexit would cause Lloyds’ profits to dry up. With the possibility of Brexit increasing, there is the talk of an interest rate cut by BoE which would hurt Lloyds because higher interest rates enable banks to earn greater sum between the money they borrow and the money they lend out.

7. Scandals (PPI Claim Saga)

Payment protection insurance (PPI), also known as credit insurance, is an insurance product that enables consumers to guarantee repayment of credit if the debtor dies or faces other circumstances. It is useful but many PPI policies have been mis-sold alongside loans and credit cards. Lloyds has taken a painful 1.1 billion pound charge so far this year for mis-selling loan insurance. Its running total is now 18.1 billion pounds, and the strikes keep coming. The deadline for PPI claims was 29 August 2019, however, we saw a rush of claims submitted before the deadline that impacted the short term profits. Lloyds continues to tackle legacy issues, including compensation payments for claims in the payment protection insurance (PPI) scandal.

Conclusion

No doubt, Lloyds shares is a cheaper option but cheap doesn’t mean good when fundamental factors fail. So I would suggest if you are looking for long term growth, there are plenty of better value stocks in the market.

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