Like getting enough sleep, avoiding social media, and building self-driving cars, buying shares below their intrinsic value is easier said than done. But it doesn’t have to be impossible.
For example, shares in Lloyds Banking Group (LSE:LLOY) have climbed 50% over the last year and now trade above the book value of the underlying business. So is the stock still cheap?
A results business
The Lloyds share price got a boost on Thursday (20 February) when the bank released its latest results. Profits might have been down, but investors were impressed with the wider news.
Pre-tax profits fell 19% in the last three months of 2024. But this was partly due to the bank setting aside £700m for potential motor loan liabilities.
On the positive side, lending margins expanded slightly during the quarter and Lloyds announced a dividend of 2.11p. By itself, that’s just over 3% of the current share price. The bank also announced plans to spend £1.7bn on buybacks – enough to reduce the share count by 4.25% at current levels.
All of this meant the stock went up over 5% in a day.
Book value
In doing so, Lloyds shares started trading at a price-to-book (P/B) ratio above 1. That’s the first time this has happened since 2019.
When a stock trades below the book value – the difference between assets and liabilities – of the underlying business, investors have a margin of safety. At least, they do in theory.
On paper, a company whose shares trade below book value could sell off its assets, pay down its debts, and give investors more than the share price in cash. That would be a good result.
Realistically, with a bank like Lloyds, this has always been unlikely. But with a rising share price meaning even that theoretical margin of safety has gone, is the stock now a big risk?
Risks
The big uncertainty with Lloyds shares at the moment is the ongoing investigation into motor loans. The bank’s now set aside a total of £1.2bn to cover potential liabilities.
There’s no guarantee, however, that this will be enough. I’ve seen estimates that the final total could be closer to £3.9bn – more than triple the company’s currently planning for.
The Supreme Court is set to rule on the issue in April. But we don’t have any special information about what the outcome of the ongoing investigation is likely to be. That makes me very wary of trying to anticipate it.
If things go well, the stock could be set for another big lift, but it’s a big risk, from my perspective.
Investing principles
By itself, the fact Lloyds shares are trading above the firm’s book value doesn’t put me off. I don’t think the prospect of the bank liquidating all of its assets was ever really on the cards.
A higher share price however, does increase the overall risk with the stock. And it means I’m not willing to buy it at today’s prices – even though I probably should have done so a year ago.
This post was originally published on Motley Fool
