Anyone would think that banks were still behaving badly. Despite delivering a solid set of results for 2021, Lloyds (LSE: LLOY) shares have lagged the FTSE 100 by more than 10% over the last 12 months.
This weak performance has left Lloyds with a forecast dividend yield of 5.3% — well ahead of the FTSE 100 average yield of 3.5%. As an income investor, I’m always on the hunt for reliable high-yield dividend stocks. Should I buy Lloyds for my dividend portfolio?
A 5% income + growth?
UK banks have struggled with low interest rates for the last decade. But rates are finally starting to rise. Lloyds’ £452bn loan book means its profits are very sensitive to changes in interest rates. Even a small increase, like we’ve seen so far, can make a big difference.
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Higher interest rates make it easier for Lloyds to increase its net interest margin. This is the profit margin between the interest paid to savers, and the interest rates charged to borrowers.
Underlying profits are expected to be fairly flat this year, but Lloyds’ conservative dividend policy means CEO Charlie Nunn is expected to have plenty of headroom to increase the dividend.
Broker forecasts suggest Lloyds’ dividend could rise by 16% to 2.3p per share in 2022, and by a further 12% to 2.6p in 2023. That gives the stock a prospective yield of 5.3%, rising to 6% next year. These estimates look realistic enough to me, unless economic conditions get much worse than expected.
Why is the market worried?
Lloyds’ share price hit a high of 55p in January, before dropping back to around 43p. I think it’s worth asking what’s worrying the market.
One obvious concern is that surging inflation and the risk of a recession could lead to a rise in bad debts. As the UK’s biggest mortgage lender, Lloyds is heavily exposed to the UK consumer economy. A housing market slowdown would probably hit the bank’s profits and could reduce its ability to pay dividends.
Even so, I think it’s worth keeping this risk in context. Lloyds balance sheet looks very strong to me. The bank’s profitability has improved and bad debt forecasts for 2022 remain very low.
While the rising cost of living is a concern, I think it’s probably fair to say that this is not affecting everyone equally.
Lloyds is a mainstream lender that generally targets people with good credit ratings. In the bank’s April trading update, Nunn said the bank was expecting a “limited impact” from the changing outlook for the economy.
Lloyds shares: my verdict
Bank shares have often looked cheap over the last decade, and they’ve often disappointed investors. But I think Lloyds looks in good shape and very reasonably priced.
Its shares currently trade nearly 25% below their book value, with a forecast price/earnings ratio of just six. There’s also that tempting 5.3% dividend yield I mentioned earlier.
In my view, Lloyds’ valuation offers a comfortable margin of safety. I’d be happy to buy the shares for my portfolio today.
