When American GIs were castigated by the British population as over-paid, over-sexed and over here during the Second World War, the antipathy of the British population was tinged with admiration. I have similar mixed feelings towards Lloyds BankingGroup (LSE: LLOY) (NYSE: LYG.US).
Its turnaround has been remarkably successful, with the benefits of self-help restructuring amplified by the unexpectedly strong recovery in the UK economy. But Lloyds is very much over here: following a Dunkirk-like retreat from Europe, it is now almost entirely dependent on the UK. Arguably, it is also over-exposed especially to the housing market and its stock is over-priced.
Reliance on the UK economy makes the shares vulnerable. Expectations that the Britain will continue to thrive are baked in. It may be a reasonable central projection, but theres plenty of downside risk. I think its significant that three component distributors, Electrocomponents, Premier Farnell and Brammer, all issued profit warnings this month, citing weak UK sales and/or intensified competition. These suppliers of bits and bobs for industry are a bellwether for that sector.
The housing market is supported by artificially low interest rates. It looks as though Bank of England Governor Mark Carney has no intention of raising rates soon, fearing deflation and no doubt reluctant to upset the apple-cart before next Mays general election, but he cant hold them down indefinitely. The national debt is larger than ever, as is the trade deficit, and the pound has lost a fifth of its value since 2008. Per-capita GDP is still below pre-financial crisis levels, and the Central Bank is cutting its growth forecasts.
The approaching General Election adds uncertainty. If the economy wobbles before May that could make a Labour victory look more likely. Some might see David Camerons red warning lights on the dashboard of the global economy as preparing the electorate for poorer-than-expected economic news. Rising anticipation of a Labour victory would be bad for stocks like Lloyds: Labour leader Ed Miliband has talked of breaking up the high-street banks.
Lloyds faces some specific challenges, too. It has built up expectations of a return to the dividend list, but its performance under the ECBs capital stress test has potentially jeopardised that. A Competition Commission review of the market for current accounts doesnt help, either.
These downside risks wouldnt be so dangerous if the shares were more reasonably priced. Lloyds forward PE is broadly in line with the rest of the sector, but in these days where banks report half-a-dozen or more profit figures, investors have paid more attention to price:book ratios. On that basis, Lloyds 1.4 price:book is significantly more expensive than its peers, highlighting how much anticipation of future growth is built into the share price.
So for me, Lloyds is a share that has many attractions, but not right now, at this price.
If not Lloyds, which is the best UK bank stock? The Motley Fool’s ‘Guide to Investing in Banks’ could help you decide which is the best bank share for you. It cuts through the complexity of bank reporting, to help you focus on the key numbers that matter. It’s completely free and without obligation. Just click here to download it.
Tony Reading has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.