With many investors nervous about the outlook for the banking sector, could that throw up some bargains? Consider Lloyds (LSE: LLOY) as an example. Over the past year, its shares are up around 5%. But the Lloyds dividend is 20% larger than a year ago.
That means the yield offered by the black horse bank has increased, now standing above 5%. Given Lloyds’ recent sizeable dividend increase and its oodles of spare cash, could adding the shares to my portfolio now turn out to be a goldmine in the long run?
Dividend potential
It is a distinct possibility. A 20% year-on-year increase in a bank’s dividend may sound unusual — and hard to sustain. But Lloyds has a lot of headway left financially.
Its annual payout per share is still well below where it stood before the pandemic (2.4p now versus 3.2p then). Even that pre-pandemic payout was far below where the Lloyds dividend stood until the 2008 financial crisis took its toll on the bank.
Just because a dividend is lower than it was never necessarily means it will hit that level again. But looking at Lloyds’ finances, the bank can amply afford not only its current dividend but a substantially larger one.
Last year for example, the bank made a post-tax profit of £5.6bn. Dividends cost less than £1.5bn, little more than a quarter of post-tax profits. The bank also spent a spare £2bn buying back its own shares.
The bank is currently undertaking another share buyback programme. Post-tax profits for the first three months of this year rose 43% compared to the same period last year. If Lloyds’ financial performance remains strong, it could amply afford to raise the dividend significantly for years to come.
Possible challenges
However, just because Lloyds currently has the financial firepower to raise its dividend does not mean that it will do so.
The board’s ongoing failure to restore the dividend even to its pre-pandemic level despite massive profits makes me think the shareholder payout is not the number-one priority for the bank. I am therefore doubtful the 20% raise seen last year will be repeated over the next few years. Instead, I expect any dividend increase will likely be on a more modest scale.
In the last full financial year unaffected by the pandemic, the Lloyds dividend grew by 5%. That is the sort of growth level I would expect to see from the bank, not 20%.
However, dividends are never guaranteed and I think the outlook is worsening for the financial services sector. Although Lloyds is performing well and benefits from its large customer base and well-known brands, it could suffer badly in an economic downturn.
As the country’s largest mortgage lender, if tightening household budgets lead more borrowers to default on loans, that could hurt profitability at banks including Lloyds.
I’m out
That is why I sold my Lloyds shares a few months ago. I have no plans to invest again in the near future.
If the bank continues to perform well and the Lloyds dividend keeps rising at its recent rate, owning the shares could ultimately be a goldmine. But I do not like the risks currently facing banks and see the 20% dividend increase as exceptional rather than the likely future norm for Lloyds.
