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I wouldn’t buy Lloyds (LSE: LLOY) shares simply because they look incredibly cheap right now, but it’s certainly a factor in their favour.
I’m building up a portfolio of FTSE 100 stocks by tracking down solid blue-chips at bargain prices, with the aim of holding them for the long term. By which I mean at least five years but ideally, the rest of my life.
The valuation is attractive
Stocks like Lloyds deliver their rewards slowly and steadily, compounding over time. Its share price isn’t going to double overnight, but with dividends reinvested, I’m hoping my total returns will prove substantial.
Cheap is charming, but also a concern. If Lloyds is such a brilliant investment, why isn’t everybody buying it?
First, its recent history is grim. Unless you’re new to investing, you will remember the financial crisis, and all the damage that did. It’s just taken the best part of a dozen years to get Lloyds Banking Group back in shape, and this has come at a cost. Basically, it has abandoned riskier but more rewarding areas of the industry, such as investment banking.
Now it’s a bog-standard domestic bank delivering savings and loans to small businesses and personal customers. Tesla, it ain’t.
And you know what? That’s fine by me. What I’m hoping is that it steadily recovers its reputation as a dividend machine, and the signs are promising. Lloyds currently yields 4.9%, well above the FTSE 100 average of 3.5%. Better still, that is covered three times by earnings, giving management plenty of scope to boost shareholder payouts.
Investors are banking on the board being progressive, and that looks the way to bet. The forecast yield is now 5.8%, which is a pretty nifty rate of income. It’s also looks sustainable, covered 2.7 times by forecast earnings.
The right time to buy?
Of course, dividends are not guaranteed, like the interest rate on the savings account. If profits fall, so will shareholder payouts. In 2018, for example, Lloyds paid a dividend of 3.21p per share. That was cut to just 0.57p in 2020, due to the pandemic.
Full-year 2022 profits, announced in February, were flat, largely due to rising impairment charges. That doesn’t worry me. Lloyds still made £6.9bn before tax. That was enough for management to announce another £2bn share buyback. It also hiked the dividend 20%, from 2p to 2.40p.
There are other risks. As the UK’s biggest lender, Lloyds could get swept up in a house price crash, and debt impairments could rise again. If interest rates are cut, that will squeeze net interest margins.
There are always risks out there, but much of these appear to be priced into today’s low valuation of 6.7 times earnings. As I’m holding for the long term, I will keep re-investing my dividends while waiting for Lloyds shares to recover lost value.
So should I buy Lloyds in May? If I hadn’t bought it last November, I definitely would. Now I might buy Barclays. I don’t own it, and it’s even cheaper still.