Key points
- Lloyds is expected to deliver inflation-beating dividend growth
- Rising interest rates could help to lift profits
- The bank’s 300-year history gives me confidence in its future
I’ve often heard investors talk about Lloyds Banking Group (LSE: LLOY) as a potential value trap. But I’m starting to think this view is unfair. Lloyds’ share price has doubled since the market crash in April 2020. I think it could still have further to go.
The bank’s performance is improving and I expect shareholder returns to increase too. I think it might still be cheap.
As an income investor, Lloyds is a share that often appears on my radar. The bank’s 300-year history tells me that it’s likely to be here long after I’m gone. And the stock’s 4.8% forecast dividend yield provides me with an opportunity to generate a market-beating income today.
I don’t have too many doubts about Lloyds’ long-term survival. But I’ve avoided buying the shares in the past because of the bank’s inconsistent growth and weak profitability since the 2008 financial crisis.
Much of this is linked to the record low interest rates we’ve lived with over the last decade. In a competitive mortgage market like the UK, low interest rates force lenders to cut their profit margins to win new customers.
For Lloyds, this has meant the bank’s return on equity has averaged just 5% since 2016. That’s not enough to tempt me, as such low returns often limit share price and dividend growth.
A turning point?
So far, I’ve been right to avoid Lloyds. Although its share price has risen by 40% over the last year, the stock is still worth 20% less than it was five years ago. The bank’s dividend has suffered too. Although profits have returned to pre-pandemic levels, Lloyds’ 2022 dividend is expected to be nearly 25% lower than in 2019.
However, I think that the prospect of rising interest rates could change the picture for the firm. The bank’s balance sheet looks very strong to me. If it was able to improve the profitability of its mortgage lending, I think profits and dividends could soar over the medium term.
My concern is that the Bank of England’s interest rate rises will be small and slow, to limit the risk of triggering a recession. That might not be enough to give Lloyds the profit boost I’m hoping for.
Lloyds share price: what next?
The good news is that even without further rate rises, Lloyds’ dividend is expected to grow much faster than inflation. Broker forecasts suggest the payout will rise by around 12% in both 2022 and 2023. With a starting yield of around 4.3%, that looks attractive to me.
Although profit growth may be more sluggish — especially if interest rates remain low — analysts expect the bank to be able to use some of its surplus capital to support more generous dividends.
On balance, I think Lloyds shares still look reasonably valued. I think the bank’s share price could continue to rise through 2022 and beyond. If I was building a FTSE 100 dividend portfolio today, I would definitely consider adding Lloyds to the mix.
