Since April 2020, Lloyds Banking Group (LSE:LLOY) shares have performed strongly. This means a sum of £5,000 invested five years ago, would now be worth £7,243. But that’s only half the story. During the same period, the bank’s declared 11 separate dividends totalling 10.9p.
When these are taken into account, the investment increases by a further £1,832.
Using dividends to build wealth
But had a savvy investor reinvested these payouts, and used the money to buy more shares, the initial lump sum of £5,000 would have grown to £14,988. This process, known as compounding, has been described as the eighth wonder of the world.
To be honest, I’ve cheated a little with these calculations. That’s because I’ve included the dividend of 2.11p that’s not yet been paid. Although it’s not due until 20 May, those holding the shares on 9 April will be entitled to receive the money. My sums have assumed that the dividend was reinvested on that date.
However, despite this impressive result, it wasn’t a particularly good period for dividends. During the pandemic, the Bank of England imposed restrictions on the amount of capital that could be returned to shareholders. In May 2021, the bank resumed payments.
Impressively, for its 2024 financial year, it declared a payout of 3.17p. Over the next three years, the consensus forecast of analysts is for this to increase to 3.59p (2025), 4.29p (2026) and 4.84p (2027).
What’s a fair valuation?
Their average 12-month price target for the bank’s shares is 75p, not far off its current (25 April) level of around 72p.
However, the most optimistic reckons Lloyds is worth 90p a share. This feels like a bit of a stretch to me. With almost all of its revenue coming from the UK, the company’s often seen as a barometer for the domestic economy. And with growth forecasts being downgraded there could be some difficult times ahead.
During an economic slowdown, banks are particularly vulnerable to bad loans. And the anticipated reduction in interest rates could squeeze Lloyds’ net interest margin (NIM). This is the difference between the amount it charges on loans and what it pays on deposits, expressed as a percentage of interest-earning assets. At 31 December 2024, it had over £450bn of these on its books.
A small movement in its NIM can therefore have a big impact on earnings.
I’m also concerned about the ongoing investigation into the alleged mis-selling of car finance. The bank’s made a provision of £1.2bn in its accounts to cover compensation, interest and administrative costs. But I’ve seen a worst-case estimate that suggests the total cost could be £3.9bn.
Given its financial strength, this is a relatively small sum for the firm to pay. Even the most pessimistic of outcomes will have little impact on its operations. However, in recent months, the share price has been particularly sensitive (up and down) to various new stories on the subject.
My verdict
To be honest, at the moment, I don’t see what’s going to drive the Lloyds share price higher. In my opinion, there’s too much uncertainty around to make a case for it continuing its recent bull run. I think there are better growth opportunities elsewhere.
However, those investors looking for a steady stream of dividends could consider the stock.
