3 reasons I’m avoiding cheap Lloyds shares like the plague

Lloyds (LSE:LLOY) shares have surged almost 27% since the start of the year. Yet despite these gains, Lloyds’ share price still offers excellent value on paper. It trades on a price-to-earnings (P/E) ratio of 9.5 times for 2025, while it also carries a sub-1 P/E growth (PEG) multiple of 0.7.

Yet even at current prices, I’m by no means tempted to add Lloyds shares to my portfolio. In fact, I believe recent price strength leaves the retail bank in danger of a sharp correction.

Here are three reasons why I think the share price of the Black Horse Bank might sharply reverse.

1. Gloomy economy

Unlike some other FTSE 100 banks, Lloyds relies solely on the UK to drive earnings. This is a major worry as economic conditions at home remain bleak.

This was illustrated perfectly by the latest official GDP data on Friday (14 March). This showed the economy contract 0.1% in January, when expansion by the same percentage had been predicted.

In this climate, retail banks like Lloyds could struggle to grow revenues, while they may also book a steady stream of fresh loan impairments. Things could get even worse for Britain’s economy, too, if it’s hit by growth-denting US trade tariffs.

The Bank of England (BoE) can support economic activity by cutting interest rates. But this scenario would create additional risks for banks by slicing their net interest margins (NIMs) — the difference between the interest they charge borrowers and pay savers — still further.

Lloyds’ NIM is already at alarmingly low levels, dropping to 2.95% in 2024.

2. Home discomforts

Supported by recent interest rate cuts, the housing market has sprung back to life in recent months. And I’m confident this upturn can continue with further BoE trimming likely in the months ahead.

But a prolonged recovery is by no means a dead cert. And this poses an extra, major risk to Lloyds given its dependence on a strong housing sector (it’s by far the UK’s largest mortgage provider).

As well as interest rate risks as inflation picks up, there’s also possible turbulence as Stamp Duty rises for first-time buyers come into effect next month. Latest data from the Royal Institution of Chartered Surveyors (RICS) showed homebuyer demand dropped to its weakest since November 2023 last month.

3. Car crash

The biggest potential threat to Lloyds’ share price in 2025, however, is a whopping penalty if it’s found to have mis-sold motor finance.

News on this front has been rather less than encouraging in recent months. Last month, Lloyds announced it has set aside £1.2bn to cover costs, which relate to claims of unlawful payments made to car retailers.

Estimates suggest this could be far below the final bill, however. Investment firm Keefe, Bruyette & Woods puts the eventual cost at more than three times this figure, at £4.2bn.

On the bright side, the case is due to be reviewed by the Supreme Court next month. And if it rules that said discretionary commissions were in fact lawful, this could have a significant positive impact on Lloyds and its share price.

However, given the current uncertainty — combined with those other major risks facing the bank — I think Lloyds shares are a risk too far.

The post 3 reasons I’m avoiding cheap Lloyds shares like the plague appeared first on The Motley Fool UK.

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Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group 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.