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At 46p, the Lloyds Banking Group (LSE:LLOY) share price looks like a bargain. An investor with £1,000 could buy 2,173 shares.
As Warren Buffett says, though, there’s much more to working out whether a stock is cheap than just looking at its share price. So are Lloyds shares good value at the moment?
Earnings
From an investment perspective, a share price of 46p might be expensive or it might be cheap. It depends on the underlying business.
Investing in stocks involves coming to own part of a company. And the return for an investor comes from the earnings the business generates.
Last year, the company generated 7p in earnings per share, meaning the stock trades at a price-to-earnings (P/E) ratio of 7. And it paid out 2p per share in dividends to shareholders.
Put another way, if I’d bought shares in Lloyds last year at a price of 46p, I’d have earned a 15% return. 4% would have been paid out to me and the rest would have been retained.
There’s no two ways about it, 15% is a really terrific return. But the question for me as an investor is how much the company is going to produce in the future.
If Lloyds is likely to generate 7p per share in earnings for the foreseeable future, then it’s cheap at today’s prices. But if its profits are going to be lower, then it might not be.
Outlook
With a business like Lloyds, there are no guarantees about the future. The company’s earnings could be 8p per share (like in 2021) or they might be 1p per share (as in 2020).
While nothing is certain, there are some clues. With a bank like Lloyds, which has the largest share of UK retail deposits, future earnings are closely linked to interest rates.
The reason the bank has made more money recently is that interest rates have been rising. This has helped the company earn more through its loans than it pays on consumer deposits.
With inflation still above 10%, the interest rate increases aren’t showing any signs of stopping. But that might not be an entirely good thing for Lloyds and its shareholders.
Higher interest rates have helped earnings over the last couple of years. But management warned that if things keep going, this could become a headwind if more borrowers default on loans.
As with all bank stocks, there’s also a risk that tighter regulations might make it harder for Lloyds to make money. That’s especially critical at a time when banks elsewhere are failing.
A stock to buy?
Ultimately, an investment in Lloyds is a bet on interest rates staying high but not too high. It’s also a bet against a crisis in the banking sector interfering with profits.
My instinct is that the stock could be a good buy at 46p. But I think there are better opportunities elsewhere, so I’m going to keep watching and waiting.
