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actions in Lloyds Banking Group (LSE:LLOY) have served investors well over the past year. The stock price has risen about 26% in the last 12 months.
In general, stocks tend to trade at bargain prices when the market looks elsewhere. But in the case of Lloyds, I think their low price is undeserved.
income streams
Lloyds has four main streams of income: net interest income, fees and commissions, trading and insurance. The largest of these is net interest income.
This comes from taking deposits (and paying interest on them) and making loans (and receiving interest on them). Mortgages make up the majority of bank loans.
Rising interest rates meant that Lloyds did very well in 2022. Its net interest margin, the gap between the interest you pay on deposits and the interest you receive on loans, has widened.
Even with the likelihood of this going down in 2023, I think it looks like a stock to buy. The business has a strong competitive position and is trading at an attractive price.
business strength
Lloyds has proven resilient in a crowded industry. The bank has maintained a strong market position despite competition from competitors such as Sampler and Monzo.
The ability to attract deposits is important for banks. Access to a low-cost deposit base is one of the things Warren Buffett cites as an advantage of Bank of America.
I think something similar happens with Lloyds. The bank has the highest proportion of retail deposits in the UK and is one of the largest providers of current accounts.
This provides the business with a low-cost source of financing that it can use to finance its loans. And it’s an advantage that other banks can’t replicate as easily.
Valuation
There is a common metric for valuing bank stocks. It involves taking the company’s return on equity and dividing it by the cost of equity to an investor: the price-to-book (P/B) ratio.
By this metric, Lloyds shares look like a bargain. With a return on equity of around 11% and a P/B ratio of 0.74, the expected return is around 15%.
That’s a very solid return. For comparison, Bank of America’s return on equity is 10% and it is trading at a P/B ratio of 1.12, giving it a return of 9%.
In addition to this, there are other avenues of growth available. Lloyds is trying to increase its credit card base to help boost its fee income.
A stock to buy
With banking, there is always the danger of loan default. Mortgages account for around 66% of the loans Lloyds has on its balance sheet, so it would be unwise to ignore this.
However, I believe that the risk of serious damage to the company from loan delinquencies is reasonably low. The company has significant reserves to cover this possibility.
Sounds like a solid business to me that is trading at a decent price. I am looking to add the stock to my portfolio in the near future.
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