Lloyds (LSE: LLOY) shares have continued their downward trajectory, falling 16% in just one month. Despite delivering good profits, the company has been buffeted by the market.
I’m always on the lookout for solid companies being unfairly treated in the short term. It’s where impressive returns can be made, after all. So, should I be buying shares of this FTSE 100 banking stalwart?
Catch-22 situation
The current UK interest rate is 2.25%. That isn’t historically high (UK interest rates reached as high as 17% in 1979), but it’s a lot higher than it has been for many years.
Higher interest rates are good for banks because they increase the amount of interest earned on the loans they make. The problem is that the inflation causing higher rates is bad for almost everyone else, including bank customers. If inflation isn’t brought under control, customers could start defaulting on loans, which is obviously not great for Lloyds.
The group has 30m customers in the UK. This means Lloyds is often seen as a bellwether for the health of the UK economy as a whole. This presents the company with a strange conundrum. What should be a positive catalyst for the stock (higher interest rates) is outweighed by the gloomy economic outlook.
Solid earnings
Lloyds reported that in the first six months of this year its net income rose to £8.5bn, up 12% on the prior year. Statutory profit after tax was £2.8bn, which was down on 2021 because of losses set aside for loan defaults.
The company offers an attractive dividend yield of 5%. Dividend cover is around three, which implies that it has sufficient earnings to pay dividends amounting to three times the present payout. This looks very solid to me.
The main risk I see is the obvious one of the UK economy deteriorating further than anyone has so far predicted. This, coupled with persistent high inflation, could make Lloyds shares fall further. On the other hand, if the UK economy holds up reasonably well, the shares could soon march higher.
Will I buy?
I tend to start small when I make an investment in a company. I’ll take a nibble at any shares I buy to get some ‘skin in the game’. This naturally leads me to take a more active interest in the progress (or otherwise) of the company. Then, all being well, I’ll gradually add more money and fill out my position over time.
However, I don’t like the fact that Lloyds is so exposed to the performance of the UK economy. I don’t see myself wanting to repeatedly add to shares of Lloyds over time.
I’m a long-term investor, and like Warren Buffett, my favourite holding period is forever. But the shares have performed poorly over a very long period, which doesn’t inspire me with much confidence. I think there are better opportunities for me elsewhere.