UK Banks: The Contrarian Bet Everyone Loves to Hate

NatWest, Lloyds, and friends are trading at deep discounts but are they bargains or traps?

Last week, fund managers quietly started to warm up to the very stocks most investors can’t stand: UK banks. While tech headlines steal the spotlight, names like NatWest and Lloyds are still sitting on bargain basement valuations. For the contrarian, that’s usually where the story begins.

Why it matters

UK banks are cheap compared to their peers abroad. Canadian banks trade around 10 – 12 times earnings. UK banks? More like 5 – 6. In plain English: investors are paying half the price for the same pound of earnings.

Yet the market doesn’t trust them. Memories of the 2008 crash still linger. Political chatter about windfall taxes won’t go away. And bond markets are screaming with gilt yields at their highest since the 1990s.

But here’s the thing: higher rates actually fatten banks’ margins, (it’s the difference between what they pay on deposits and what they earn on loans). That gives banks a cushion, at least for now. If inflation eases and loan defaults don’t spike, these unloved lenders might finally deliver.

Investor Rationale

Lets look through the accounts and ask yourself the following two questions before taking a deeper dive.

Q: Does this bank earn more than it costs to run, and can I buy it for less than it’s worth on paper?” If yes, then start diving.

Q: Are people still scared of ghosts from 2008?” If so, maybe that fear has left bargains lying around. It’s worth a look.

These two very simple questions set the tone, your own analysis flushes out the opportunity.

Evidence & metrics

Right now, UK banks are going cheap: you’re paying about £5 - 6 for every £1 of annual profit (that’s a P/E of 5 – 6). In Canada or Australia, the same pound of profit costs you double.

Take Lloyds: on paper it’s worth £1 per share, but you can buy it for about 70p in the market. That’s like buying £10 notes for £7.

They’re not under capitalised either. Big UK banks hold about 14% capital buffers (that’s their rainy day fund to absorb losses) they are comfortably above the rules.

And while you wait, the dividends aren’t bad: 5% from NatWest, 6% from Lloyds. That’s like having a solid savings account, only with a bit more risk.

Risks & counterpoints

The obvious bear case: if people start falling behind on loans and mortgages, banks eat the losses and profits disappear fast. We’ve all been here before. .

Politics could spoil the party. Another windfall tax or tighter rules and suddenly those cheap valuations make sense.

And if the Bank of England cuts rates quickly, the banks earn less on the gap between deposits and loans. The margin cushion shrinks.

What a smart investor would do next

1. Line them up side by side. Which bank is selling for less than it’s worth on paper (P/B < 1) and still paying you a dividend? That’s your starting point.

2. Watch the bad loan numbers. If provisions (the money set aside for defaults) stay low, that’s a green flag. If they start spiking, be cautious.

3. Don’t buy the whole bunch. Pick one or two with the strongest finances and most consistent payouts, rather than betting on the whole sector.

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⚠️ Disclaimer:
This is for educational purposes only, and is not financial advice. Always do your own research before making investment decisions.