I’d buy 95,239 shares of this banking stock to generate £200 of monthly passive income

Muhammad Cheema takes a look at how Lloyds shares, with a dividend yield of 5.9%, can generate a healthy monthly passive income.

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Lloyds Banking Group (LSE:LLOY) shares have had a pretty torrid 2024 so far. However, I believe that the 10% share price decline presents an excellent passive income opportunity for me to consider.

How to make £200 a month with its shares

Lloyds shares are currently trading for 43.16p apiece and provide a dividend yield of 5.9%.

While keeping in mind that dividends aren’t guaranteed, if I spent £40,933.33 (I appreciate that this isn’t a trivial amount of money, and I wouldn’t want to unbalance my portfolio, of course) to buy 95,239 of its shares, I could generate an extra £200 a month. To calculate this, I’ve used the interim dividend of FY23 and the final dividend of FY22.

The additional income I’d make would also likely rise over time. The interim dividend in FY23 was 15% higher than the interim dividend in FY22. It’s possible that the final dividend in FY23 could also increase by a similar amount. Therefore, the extra £200 a month may just be the starting point of additional income I’d make.

Furthermore, if I reinvested all or part of the dividend back into the stock, I could make even more.

Dirt-cheap valuation           

Lloyds shares are also trading at a ridiculously cheap valuation with a price-to-earnings (P/E) ratio of only 4.4.

When a P/E ratio is this low it could lead investors to believe that this is representative of a value trap.

But I struggle to see how this can be the case when net income increased by 7% year on year to £13.7bn in the nine months to 30 September 2023. Profit after tax was even more impressive, growing by 46% to almost £4.3bn.

With such a performance, I believe that Lloyds shares are trading at bargain territory.

Concerns

I do have a couple of concerns with Lloyds shares.

Firstly, it’s heavily dependent on the UK economy. The UK entered into a recession last year, which could incentivise the Bank of England to lower interest rates, as is predicted. As Lloyds generates a large majority of its income from lending, its net interest income (NII) could be seriously affected. This could hamper further revenue growth over the short to medium term.

Secondly, the FCA is reviewing historic motor finance commission arrangements. Lloyds is the owner of the UK’s largest auto lender, Black Horse, and it’s being speculated that there could be potential compensation payments. The FCA is still in the early stages of its review, so it’s too soon to know what the outcome will be, but it’s worth a thought.

Now what?

There are some risks due to the economy. If interest rates fall, then Lloyds’ NII could fall. However, it’s not as simple as that. If interest rates fall and the UK economy starts growing again, Lloyds will benefit from fewer people defaulting on their debts. Furthermore, better economic conditions could incentivise more people to take out mortgages. As the UK’s largest mortgage lender, this will further benefit Lloyds.

As a Foolish investor who focuses on the long term, its shares are too cheap to ignore and it provides me with a great opportunity to make a second income.

That’s why if I had the spare cash, I’d buy Lloyds shares today.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Muhammad Cheema has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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