For many investors, passive income is the holy grail of investing. After all, we can always reinvest this passive income if we don’t need it, perhaps as part of a compound returns strategy.
Moreover, investing in dividend-paying stocks is often seen as a less risky strategy than focusing on growth stocks. Personally, I’d rather invest in a reliable dividend stock than a promising growth stock.
So, that brings me to Lloyds, my favourite dividend stock. Let’s take a look at how many shares I’d need in this UK bank to achieve £1,000 a year in passive income, and why I like it so much.
Passive income
Lloyds actually went ex-dividend on Thursday. The total dividends for 2022 came in at 2.4p per share, meaning a dividend yield of 5% at the current price.
So, it’s quite an easy calculation. If I wanted £1,000 of passive income, I’d need £20,000 in Lloyds shares. That equates to 41,666 shares. That’s a considerable investment but it could be one of the best places to invest for sustainable dividends.
One reason I like this dividend stock is the strength of the dividend coverage. The dividend coverage ratio (DCR) measures the number of times a company can pay its current level of dividends to shareholders.
Normally a dividend coverage ratio around two would be considered healthy. However, it’s also worth bearing in mind that companies with strong cash generation can have healthy dividend yields despite having lower coverage ratios.
So, for 2022, Lloyds had a DCR of 3.04. That’s very strong, especially for a company that’s offering a 5% yield. In fact, I’d estimate that it may be the strongest on the index, perhaps with the exception of more cyclical mining stocks.
City analysts have forecast the bank’s dividend rising to 2.7p and 3p in 2023 and 2024 respectively. The 2024 figure represents a 25% increase from 2021.
More things that are great about Lloyds!
Obviously, every stocks has its pros and cons. Lloyds is a UK-focused bank without an investment arm. This means it’s less diversified than its peers. Diversification tends to be a good thing, but Lloyds’s lack of diversification means it has greater interest rate sensitivity than its peers.
Rising mortgage rates are a big deal for banks. But interest rates are getting a little too high right now. This means more defaults and higher impairment charges. This is certainly a risk in the short term — we also may see something of a credit crunch if more loans turn bad.
But the medium-term forecast is for Bank of England rates to moderate to between 2% and 3%. That’s ideal for banks as they can benefit from higher net interest income, while impairment costs remain low — assuming there’s no adverse economic event.
It’s also worth noting that Lloyds is earning a small fortune from its central bank deposits right now. Analysts suggest that every 25 basis point hike is worth £200m in interest revenue from BoE deposits alone.
So, despite so near-term concerns, I’m buying more Lloyds shares — although I don’t quite have £41,666. I think it’s an excellent dividend stock that trades at just 6.8 times earnings.
