Lloyds Banking Group (LSE: LLOY) shares have climbed 33% since mid-October last year. Buying for further recovery potential is tempting, especially given the share’s current low valuation.
Forecasts value Lloyds shares on a price-to-earnings (P/E) ratio of around 7.5. Analysts think the UK high-street bank is worth only half the long-term FTSE 100 average.
For a bank so closely tied to the long-term UK economy, I think that’s crazy cheap. And predictions show the valuation falling even further in the next couple of years.
But that’s not my main reason for wanting to buy more Lloyds shares in 2023. No, 2022 full-year results hinted at the key attraction for me.
Dividend
Lloyds declared a full-year dividend of 2.4p per share, up 20%. On the current price, that’s an attractive yield of 4.7%.
Forecasts see the dividend yield hitting 6% by 2024 too. I treat that with caution, certainly. But the 2022 dividend was three times covered by earnings. And Lloyds reckons its capital generation should continue to grow steadily between now and 2026.
Are Lloyds’ dividends the key feature for me? Well, sort of, but not entirely. I do invest mainly for dividends, which I always reinvest for the long term. But there’s something more fundamental lying behind it all.
Downside
Before I get too excited, there definitely are risks with Lloyds. I know that from experience, having made my first Lloyds investment at close to double today’s share price.
High interest rates currently provide a boost for bank profits. And for 2023, Lloyds expects a net interest margin above 3%. That’s high by long-term standards. And it’s got to be affected when Bank of England rates come down.
Exposure to the housing market makes for further risk, with Lloyds being the UK’s biggest mortgage lender.
Reason to buy
The one thing I like above all when it comes to a bank like Lloyds is its capital generation. Without that, there’d be no dividends. And there’d be little to drive share price valuations.
The Lloyds board has decided to return up to £2bn in spare capital to shareholders by way of a share buyback, which has already started. That’s a lot of money, especially when the banking sector is supposedly facing a hard time.
It does lend strength to the argument that Lloyds shares are cheap now. After all, a company board would surely find a better way to return cash if it thought its own shares were expensive.
Total returns
Whichever way a company decides to pay its shareholders, total returns are what matter. On that score, Lloyds’ total capital returns for 2022 come to a whopping £3.6bn.
This is in a year when the bank took a £1.5bn underlying impairment charge. And when the board understands the current pressures on property prices and future pressures from falling interest rates.
If that’s what Lloyds can achieve for shareholders in a year like 2022, I’m trying to imagine what might be possible when inflation is under control, UK economic growth is back, and impairments are a thing of the past.
