Investors in Lloyds (LSE: LLOY) (NYSE: LYG.US) shouldn’t lose hope in the prospects for the part-nationalised bank. In fact, Lloyds could have huge potential despite posting disappointing share price returns during the course of 2014, with the bank’s share price currently being down 6% year to date. This is behind the FTSE 100‘s 1% decline, but the rest of 2014 and beyond could prove to be far more enjoyable for investors in Lloyds. In fact, its share price could make gains of 44%. Here’s why.
Vast Yield Potential
A key reason why Lloyds could see its share price move higher over the next couple of years is dividend growth. Indeed, a combination of a higher payout ratio and growing profitability could prove to be a highly potent combination that pushes Lloyds’ shares higher. For instance, Lloyds is aiming to pay out around 65% of profit as a dividend in 2016, with the ratio increasing from this year’s forecast of 17% over the next couple of years until it reaches its desired level. In addition, Lloyds’ bottom line is expected to grow by 7% in 2015 alone.
The impact of these two factors could be significant. That’s because Lloyds currently has a yield of 4.3%, which is impressive and ahead of the FTSE 100’s yield of 3.6%. However, that assumes a dividend payout ratio of just 39% in 2015. Even if we are conservative and assume zero growth in Lloyds’ profitability between 2015 and 2016, a payout ratio that increases to 65% in 2016 (which is the bank’s target) would mean that Lloyds trades on a forward yield of 7.2% at current prices.
Certainly, 2016 is another 16 months away, but if Lloyds looks set to meet (or get close to) its payout ratio target in 2016, shares could move a lot higher in the meantime as investors bid up their price to take advantage of a highly lucrative forward yield of 7.2% (at current prices).
Looking Ahead
Even if Lloyds were to trade at a forward yield of 5% based on 2016’s dividends per share, which is itself a highly attractive yield, it would equate to share price gains of 44% from the current price of 74p. In other words, investors could bid up the price of Lloyds’ shares so as to reduce the forward yield (using 2016’s dividend per share forecasts) of 7.2% to 5% over the next couple of years.
The question is; can Lloyds actually afford to pay out 65% of profit as a dividend? The answer to that is very much a ‘yes’, since the banking sector continues to benefit from an improving UK economy where PPI provisions are likely to become smaller going forward and where write-downs and bad loans are likely to continue their downward trajectory over the medium term.
Although 2014 has been disappointing for shareholders in Lloyds, a 44% increase in its share price over the next couple of years is very achievable. After all, this is the bank that gained 61% in 2013 alone.
