How To Get A 6% Dividend Yield From Lloyds Banking Group PLC

Last year was one to remember for investors in Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US). The bank’s share price soared a thrilling 60%, despite bad news about continuing provisions for PPI claims and the general fug surrounding the sector in general.

However, 2014 has been more testing. After a brief rally to 86p, the share price has drifted down to around 76p — not helped by today’s news that the Treasury is selling a further 7.5%  of its stake in Lloyds to the private sector — and it’s flat on the year so far.

Perhaps we shouldn’t be surprised to see the shares taking a breather after last year’s rapid ascent. There’s been plenty to cheer shareholders in recent months – a stronger UK economy and strengthening house prices, for example, as well as an end in sight to those relentless PPI reimbursements – but the stock market had anticipated most of this last  year, which was what fuelled the share price rise.

Lloyds is now price at 1.5x book value, and is on a P/E of nearly 11. That’s not expensive, but it’s not a screaming bargain any more, either.

Incoming income

However, there is a good reason to stick with Lloyds and that is for its future dividend payments.

Over the past few years Lloyds’ chief executive António Horta-Osório has striven to turn Lloyds into a utility-style bank that pays a decent dividend to shareholders. It may not offer the growth or high returns that some of the big banks touted before the crisis (though we know how well that turned out) but a steady and growing dividend from a dominant bank in a rich country like the UK is not to be sniffed out.

“Wait a minute”, I hear someone cry. “What dividend?”

It’s true that Lloyds’ ordinary shares have paid out precisely zilch for the past few years. But that is set to change.

On average analysts expect Lloyds to pay out 2p per share this year, which would make for a dividend yield of 3%. And with the economic climate fast improving and Lloyds (hopefully) running out of profit-destroying skeletons in its closet, I think there’s good reason to think we’ll get it.

A 6% yield from the Black Horse

It gets better. In February, Horta-Osório had this to say about dividends from Lloyds:

“We also expect to apply to the regulator in the second half of the year to restart dividend payments at a modest level and to deliver progressive and sustainable payments to shareholders thereafter.”

What does progressive and sustainable mean in practice?

If Lloyds does become effectively a banking utility that’s run safely and conservatively, with more of its earnings paid out to shareholders as a dividend rather than reinvested for gung-ho growth, then we might expect dividend cover of 1.5x – or to put it another way that it will return about two-thirds of its earnings to shareholders.

Analysts currently expect Lloyds to earn about 8.3p in 2015. Let’s be slightly cautious and say it manages 8p.

If the bank paid out two-thirds of its earnings per share as a dividend, that would equate to about 5.3p. Let’s call it 5p, again to not be too greedy.

With the shares at 79p, that would be a dividend yield of over 6%.

Buy now, get paid later

Admittedly, it might turn out that we have to wait perhaps another year or two beyond 2015 for Lloyds to pay out 5p per share as a dividend. But equally, as Lloyds rebuilds its income credentials, it’s likely the share price will follow.

So now may be the best time to buy to secure that 6% yield on your purchase price. When Lloyds is paying out 5p a year, the share price will probably be much higher.

Of course it will be a long time – if ever — before even the steadier banks like Lloyds are considered truly safe investments again, which may mean bolder investors still have an opportunity to pick up the shares more cheaply.