Global markets have been on edge so far in May as news headlines highlight that the US-China trade negotiations may be at an impasse. Understandably, many investors are increasingly looking to generate safe income from dividend-paying stocks, such as bank shares.
For income-centric portfolios, I generally consider shares with dividend yields over 4%. My primary goal is to achieve roughly a 7% to 8% income annually while preserving the capital over time. One stock that is currently on my radar for such a portfolio is Lloyds Banking Group (LSE: LLOY), the largest retail bank in Britain, as well as one of the biggest dividend payers.
Dividends and stock repurchases
In 2018, Lloyds paid a total ordinary dividend of 3.21p per share, meaning a current dividend yield of 5.2%. The bank currently pays out dividends twice a year, last paid on 21 May. However, from Q1 2020, the payments will become quarterly.
It will start paying three equal interim ordinary dividend payments followed by a larger final dividend for Q4, subject to the group’s performance. This change in payment scheduling is likely to appeal to many investors who would like to structure their dividend income more frequently during the year.
In 2018, the group had also announced a share repurchase programme of £1.75bn.
In other words, the bank currently rewards long-term investors with generous cash distributions in terms of dividends and buybacks.
Can the share price recover?
Following the financial crisis a decade ago, the fundamentals of LLoyds have clearly been on the mend.
Its full results for the year ended 31 December 2018 showed that net income rose 2% to £17.8bn, in line with forecasts. One of the numbers that investors cheered the most was net interest margin (NIM) – a profitability ratio measuring how well a bank is making investment decisions. It increased slightly to 2.93%.
The banking giant earns the over 70% of its income from net interest income (NII) in the basic banking function of taking deposits and making loans. Therefore increasing NIM is important for profit levels.
One of the most important metrics for Lloyds is the bank’s cost-to-income ratio, which shows a bank’s efficiency – the lower the ratio, the more profitable the bank will be. Lloyds shines with 44.7%, one of the lowest of any UK bank.
Year-to-date, the share price is up over 14%, currently hovering around 60p. However, in May 2015, it had almost hit 90p. Since then, to the dismay of long-term shareholders, the stock price has been in decline.
At this point, I have to remind our readers that Lloyds is primarily a deposit-gatherer and lender with full exposure to the UK economy. Therefore the group can be regarded as a proxy for our economy.
Strong economic growth is crucial for the performance of banks. There is no denying that especially since 2016, Brexit fears have negatively affected the share price. Although I believe that any further Brexit-related weakness is possibly baked into the price, investors in bank stocks should always keep economic factors in mind.
The bottom line
Variables such as interest rates, economic growth, global trade worries, and activity in the housing markets can impact a bank’s stock price. So there will likely be daily price swings in Lloyds stock as headlines change. Yet I’d give the group the benefit of the doubt and be a buyer of the shares on any short-term weakness.
