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UK bank stocks have fallen. Should I buy them now?

Young Black woman using a debit card at an ATM to withdraw money
Young Black woman using a debit card at an ATM to withdraw money

UK bank stocks have been getting a bit of attention recently. This could be due to the fact that most are well off their 52-week highs?

Currently, I don’t own any bank stocks in my portfolio. So is now the time to buy some? Let’s discuss.

These stocks are dirt-cheap

I can certainly see some appeal in these stocks right now. For starters, they look cheap relative to the market. The table below shows the forward-looking price-to-earnings (P/E) ratios of the UK’s largest five banks.

Stock

P/E ratio

Lloyds

6.5

Barclays

4.7

HSBC

7.0

NatWest

7.4

Standard Chartered

6.5

Those P/E ratios are low. To put the numbers in perspective, the median P/E across the FTSE 100 index is about 13.5, at present. So there could be potential for share price appreciation here.

One reason to be optimistic about share prices is that profits across the sector are getting a boost from higher interest rates. Banks generate a large chunk of their income from the spread between lending and borrowing rates. The higher rates go, the larger the spreads they can generate.

We saw this in Q3. For example, HSBC’s net interest income surged 30% to $8.6bn, thanks to higher rates. Looking ahead, central banks are likely to continue increasing interest rates in an effort to bring down inflation. So banks’ profits could get a further boost.

Attractive dividend yields

Secondly, there are some attractive dividend yields on offer across the sector at the moment. This table shows prospective yields using analysts’ current dividend forecasts (these shouldn’t be relied upon).

Stock

Dividend yield (%)

Lloyds

5.3

Barclays

4.6

HSBC

5.2

NatWest

9.4

Standard Chartered

2.7

As you can see, Lloyds, HSBC, and NatWest all have yields in excess of 5% right now. In today’s choppy market, a 5%+ yield is attractive, in my view.

One major risk

Of course, the big risk here is the economy. Banks’ performances are closely linked to economic conditions and, right now, conditions look ominous.

Last week for example, the Office for Budget Responsibility (OBR) said that the UK economy (which is already in a recession) is set to shrink by 2% in the next 18 months, leading to over half a million job losses by the second half of 2024.

The medium-term fiscal outlook has materially worsened since our March forecast due to a weaker economy, higher interest rates, and higher inflation”, said the OBR.

If economic conditions do continue to deteriorate, I’d expect the banks to see higher loan losses. This could lead to lower earnings (and possibly lower dividends too). In this scenario, the stocks may not look so cheap after all.

It’s worth noting here that in HSBC’s Q3 results, it posted expected credit losses (ECL) of $1.1bn, versus $659m a year earlier. This dragged pre-tax profit down 42% to $3.1bn.

Long-term threat

Another issue for long-term investors like myself to consider is the huge amount of disruption in the financial services sector. Right now, FinTech companies such as Revolut, Monzo, and Wise are capturing banking market share. Traditional banks such as Lloyds and Barclays are going to have their work cut out to retain customers.

My move now

Weighing this all up, I’m not in a rush to buy bank stocks for my portfolio right now. Sure, the sector looks cheap. But that’s because economic uncertainty is high.

All things considered, I think there are better stocks to buy for my portfolio today.

The post UK bank stocks have fallen. Should I buy them now? appeared first on The Motley Fool UK.

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Edward Sheldon has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays, HSBC Holdings, Lloyds Banking Group, Standard Chartered, and Wise plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2022