I’m always on the lookout for investments, particularly dividend shares, that can do well over the next 10 years and beyond. And I think the UK banking sector looks like a promising place at the moment.
One of the shares catching my eye is Lloyds Banking Group (LSE:LLOY). I think there are encouraging signs from both the stock and the underlying business.
Returns on equity
Lloyds makes money by lending out money and charging interest on it. To finance this, it takes in customer deposits (and pays interest on them).
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One way of measuring how efficiently a bank does this is by looking at its return on equity. At the moment, Lloyds is generating a 12% return on equity.
It’s worth noting, though, that this is unusually high. Over the last decade, Lloyds has managed an average return on equity closer to 7%.
Lloyds’s return on equity
Created at TradingView
Nonetheless, with the stock currently trading at a price below the accounting value of its equity, I think this looks attractive. And there’s another important point to consider.
Book value
Rising returns are an encouraging sign. But if the value of the company’s equity (its book value) is falling, then there’s a limit to how positive this is.
For example, if a company’s return on equity goes from 10% to 12%, this is positive. But if its book value declines from £1bn to £750m, the profits fall from £100m to £90m.
With Lloyds, however, this isn’t the case. In fact, the reverse is true – as efficiency has increased, the bank’s equity has grown on a per-share basis.
Lloyds’s return on equity vs. book value per share
Created at TradingView
The result has been a big boost to the company’s profitability. And a lot of that is set to come back to shareholders over the next few years in the form of dividends and share buybacks.
Interest rates
One reason Lloyds has been more profitable lately is a helpful macroeconomic environment. Higher interest rates have allowed the bank to make more money on loans, boosting returns on equity.
Lloyds’s return on equity vs. UK interest rates
Created at TradingView
This indicates an obvious risk with the stock going forward, though. If interest rates stop rising, then the upward trajectory might stop and future returns might not be so impressive.
As I see it, though, this is already being reflected in the share price to quite a significant extent. The stock is trading at one of its price-to-book (P/B) multiples since 2010.
Lloyds’s return on equity vs. price-to-book ratio
Created at TradingView
Moreover, the gap between the bank’s return on equity and the P/B multiple its stock trades at is the widest it has been in years. That’s a sign the market is already pricing in lower future returns.
A stock for 2034?
For Lloyds, a lot hinges on what happens with interest rates over the next decade. While I’m expecting them to come down, I’m not expecting them to be as low as they have been.
Lloyds currently has strong returns on equity, a growing book value, and a low valuation. So if I’m right about interest rates, it could be one of the best dividend shares to own for the next 10 years.
