On a relative basis, the last three months have been positive for investors in Lloyds (LSE: LLOY). That’s because shares in the part-nationalised bank have risen by 2.5%, while the FTSE 100 has fallen by 5% during the same time period.
This outperformance could be set to continue, as Lloyds proceeds with its sound strategy of asset disposals and is repositioning the risk/reward ratio so that it is much more favourable moving forward.
In addition, Lloyds could become a ‘must-have’ income stock over the next couple of years and, in 2016, could be yielding over 7%. Here’s how.
Payout ratio
Although Lloyds hasn’t paid a dividend since before the onset of the credit crunch, it is due to resume them in the current year, as the bank is expected to return to profitability in 2014. This would be a major step forward for the bank, as it is yet another sign that it is returning to full health and could help to firm up sentiment even further over the short run.
Furthermore, Lloyds is not holding back on its plans to become the most shareholder-friendly bank. Indeed, it is aiming to pay out up to 65% of profit as a dividend in 2016. This figure may seem rather excessive at first glance. After all, we are only a few years out of the biggest banking crisis in living memory.
Lloyds, though, seems to be well capitalised and, as such, does not need to retain the vast majority of its profits each year. In turn, this means that it should be able to pay the majority of earnings to shareholders in the form of a dividend without risking the overall financial health of the company.
Increased Dividends
With Lloyds being forecast to deliver earnings per share (EPS) of 8.2p in 2015, it seems as though the bank is set to make encouraging progress with regards to its bottom-line growth. However, being conservative and assuming that Lloyds does not increase earnings from 2015 to 2016, a 65% payout ratio in 2016 would equate to dividends per share of 5.3p. With shares in Lloyds currently trading at 73p, this would equate to a dividend yield of 7.3%, assuming no change in the bank’s share price.
Of course, a yield of 7.3% may sound excessive. After all, it’s more than twice the current yield of the FTSE 100. However, if Lloyds is able to meet its current forecasts for 2015 and then delivers zero growth in 2016, a yield of 7.3% appears to be very achievable.
Indeed, it could be argued that, with an improving UK economy and a sound strategy, Lloyds could grow earnings between 2015 and 2016, thereby giving an even higher potential yield over the medium term. As a result, Lloyds could become a hot income ticket a lot sooner than the market is currently pricing in.