The financial sector is usually the last place investors look when hunting for yield. Indeed, the banking sector’s average dividend yield currently stands at 3.5%, which is nothing to get excited about. The FTSE 100’s average is similar.
And apart from Asian banking giants, HSBC (LSE: HSBA) and Standard Chartered, which support dividend yields of over 5%, the majority of banks now only offer a token dividend yield.
However, some banks, including HSBC, Barclays (LSE: BARC) and Lloyds (LSE: LLOY) have all the qualities needed to make the perfect dividend portfolio.
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Growth and income
The best income and dividend investments have three main qualities.
- The dividend has room to grow.
- The dividend on offer is greater than inflation.
- The payout is sustainable in the long-term.
HSBC’s payout meets two of these three criteria. The bank is well capitalised and the payout is well covered by earnings per share, so the dividend is sustainable. What’s more, HSBC’s monster dividend yield of 5.4% is three times more than the current rate of inflation — 1.6% as measured by the Retail Prices Index during December 2014.
Nevertheless, HSBC’s dividend payout does not have much room for growth. The bank’s profit margins are coming under pressure from rising regulatory costs and the amount of profit available for distribution to investors is falling.
Still, with a sustainable dividend yield of 5.4% HSBC is a solid backbone for any dividend portfolio.
Room for growth
Lloyds is yet to reinstate dividend payments but the bank’s management is fully committed to this goal.
The bank is seeking permission from regulators to restart dividend payments again this year. If the group finally gets the go-ahead, analysts believe that the bank will pay a dividend of 2.8p per share for 2015 — a yield of 3.7%.
However, over the long-term, City experts believe that the bank will return around 70% of income to investors. If City predictions prove true and the bank does hike its payout ratio to 70%, then with earnings of 8.6p per share forecast for 2016, Lloyds’ could offer a dividend payout of 5.6p per share, a yield of around 8%.
So, Lloyds and HSBC make the perfect partnership. As HSBC’s payout stagnates, Lloyds’ hefty dividend yield and rapid payout growth will provide investors with an additional source of income.
International
Even though Lloyds’ payout is set to grow rapidly over the next few years, over the longer term, just like HSBC, Lloyds could struggle to produce dividend growth. This is because the group does the majority of its business inside the UK and with competition increasing, Lloyds’ earnings and dividend payout cannot continue to expand rapidly forever.
Barclays on the other hand should be able to achieve this long-term earnings and dividend growth. The bank’s international exposure, especially to Africa should enable Barclays to benefit from global economic growth and, if it does, shareholders will benefit.
Indeed, over the next two years alone, City analysts expect the bank’s earnings to expand by 50% between 2014 and 2016. As a result of this growth, analysts expect Barclays’ dividend payout to rise to 12.2p per share by 2016, equal to a yield of 5.4% based on the current share price.
A basket of income
Overall, Barclays, Lloyds and HSBC make the perfect income portfolio. Barclays offers long-term dividend growth. Lloyds is on target to offer a high-single-digit yield within the next few years and HSBC currently offers an attractive yield that will form a decent backbone for any portfolio.
