Since the UK voted to leave the EU, Lloyds (LSE: LLOY) has slumped by around 24%. That’s largely because of uncertainty regarding the future for the UK economy. Lloyds has considerable exposure to the UK – especially following its acquisition of HBOS during the credit crunch. So reduced demand for new loans from businesses and consumers as well as falling house prices could be very bad news for Lloyds.
However, as with any investment, the risks can be high as long as the potential rewards are also very generous. In other words, Lloyds may now offer greater risks than it did before the EU referendum, but with its shares being 24% cheaper their potential rewards from an upward rerating are higher.
In fact, Lloyds now trades on a price-to-earnings (P/E) ratio of just 7.1. For a banking major that has returned to profitability in recent years and is now on the cusp of becoming a full plc once more as the government edges towards selling its stake, this seems to be unjustly low. Furthermore, Lloyds is now in a much stronger position in terms of its efficiency ratio, balance sheet strength and its profit outlook than it has been at any time since the start of the credit crunch. Therefore, it looks to be in good shape to survive a prolonged downturn and emerge in a stronger position relative to its peers.
Stalling share price growth?
Clearly, nobody knows exactly what the outcome of Brexit will eventually be. However, it seems likely that a period of great uncertainty is now set to become the norm and Lloyds’ share price could realistically be held back for a number of years. For example, article 50 of the Lisbon Treaty hasn’t yet been invoked and once it is, there will be around two years of negotiations prior to the UK leaving the EU. Once that’s done, the UK will then have to go it alone and uncertainty will inevitably be high as the UK takes an unprecedented step.
Therefore, Lloyds’ shares could move lower during the next few years. Its profitability could come under severe pressure and many investors may panic sell, worrying that it’s the banking crisis of the Credit Crunch repeating itself.
However, Lloyds is in sound financial shape and it has a very wide margin of safety. This shows that now could prove to be a great time to buy it for the long term – even if its shares fall in the interim period. And if they do, Lloyds has a yield of over 8% to generate a superb income return for its investors that can then be used to invest in other bargain basement opportunities.
Buying Lloyds now requires a long-term view and a huge dollop of patience, since things could go from bad to worse. However, the long-term rewards could be staggering.