On the face of it, National Grid (LSE: NG) (NYSE: NGG.US) is a far more appealing income stock than Lloyds (LSE: LLOY) (NYSE: LYG.US). That’s because it currently yields 5.1%, while Lloyds has only just recommenced the payment of dividends and is expected to yield around 3.5% in the coming year.
However, delving deeper than just the headline yield shows that, in the long run, you may receive a higher income from shares in Lloyds than from holding a stake in National Grid. Here’s why.
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While Lloyds has endured a hugely challenging period in recent years, with the credit crunch causing its bottom line to plunge to major losses, its future looks set to be extremely profitable. Certainly, there remain a number of problems that Lloyds and its sector peers will need to overcome, notably regulatory issues, PPI claims and a slow-growing Eurozone, but things really do seem to be on the up for Lloyds.
Furthermore, the bank is still targeting the payment of around 50% of earnings as a dividend and, in the long run, Lloyds’ payout ratio could rise to the 65% figure that its CEO is believed to be aiming for. As such, Lloyds is expected to yield 5.2% in 2016 from a payout ratio of 50%, which is exactly the same as National Grid is forecast to yield in the 2016 calendar year. As a result, following their difference in yield in the current year, the two stocks are tied when it comes to which is the higher income payer in 2016.
However, where Lloyds could surpass National Grid with regard to dividend payments is in terms of its future prospects. Finally, the ECB has decided to undertake a quantitative easing programme and, while it may not prove to be a ‘silver bullet’, it could mean that the growth prospects for the UK and global economies improve significantly. This would mean higher asset prices, higher demand for new loans and fewer bad loans moving forward – all of which would bolster Lloyds’ profitability. And, with its commitment to paying 50%+ of profit as a dividend, shareholders would be beneficiaries of any improved performance.
On the other hand, National Grid’s profit growth prospects are somewhat limited. Certainly, it has the potential to keep up with the wider market’s growth rate but, realistically, regulatory involvement and rising interest rates (which will cause its debt to become more expensive to service) could cause its bottom line to rise at a more modest pace than that of Lloyds.
So, while their headline yields currently differ and National Grid rightly has a reputation as a top income stock, Lloyds could prove to be an even better investment when it comes to dividends.