Lloyds (LSE:LLOY) shares are among the most traded on the FTSE 100. But I’d still argue that they’re rather unloved and offer considerable upside.
I already own Lloyds shares, but I’m intending to buying more this month in an effort to enhance my passive income generation and propel my portfolio forward. In fact, if I bought 11,000 shares in the banking group, I could hope to recoup £1,250 in dividends over the next five years.
That’s clearly a positive return, but I’d also expect to see some share price growth too. So let’s take a close look at Lloyds.
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Attractive dividends
The current 4.2% dividend yield isn’t the biggest on the FTSE 100, but it’s larger than the majority of dividend-paying stocks. And, to be honest, I’m quite happy with that yield from a reliable and largely unexciting stock like Lloyds.
And, despite the tough economic conditions, City analysts are forecasting a full-year dividend of 2.4p in 2022, rising to 2.7p and 3p in 2023 and 2024 respectively. The 2024 figure represents a 25% increase from the current position.
That means if I were to buy at the current price, my dividend yield would be 6.25% in 2024.
The dividend could well rise in 2025, 2026 and beyond. But let’s imagine the yield averaged at 5% over the next five years, relevant to the current price. If I bought 11,000 shares today for £5,000, over that five year period I could recoup £1,250 — equivalent to 25% of my investment.
Outperforming
But I’m backing Lloyds to outperform the market over the next five years. So I’d hope to see share price gains in addition to my dividends.
Lloyds has been trading at a discount for some time. In fact, some discounted cash flow models suggest the stock could be undervalued by as much as 60%. That’s considerable and would provide me with a huge margin of safety.
There are also near-term tangible tailwinds in the form of higher interest rates, and regulatory change that could provide the banking sector with a much-needed boost.
With the Bank of England pushing the base rate up more than 300 points last year, net interest margins (NIMs) have risen, and continue to rise. The bank recently said the NIM was forecast to reach 2.9% by the end of the year (2022), and it could grow further this year.
Lloyds is even earning more interest on its deposits with the central bank. Lloyds could be pulling in around £2.5bn in extra revenue from its £145.9bn of eligible assets and £78.3bn held as central bank reserves.
There are, of course, challenges and most of these are presented by the forecast recession. Lloyds has already had to put money aside for bad debt provisions. In Q3, impairment charges soared to £668m from a release of £119m a year before as bad debt concerns increased.
But I’m hopeful not all of these funds will be needed and it looks like higher rates will continue to propel earnings forward.
