Lloyds (LSE:LLOY) shares have been enormously popular with dividend investors down the years. Can they still claim to a top Buy for passive income, though? I’m not so sure.
At 94.3p, Lloyds’ share price has rocketed 72% since 1 January. As a result, dividend yields on the FTSE 100 bank have collapsed below the long-term average.
That’s not the only worry I have as a stock market investor myself. Is Lloyds a dividend share investors need to think about avoiding today?
Great qualities
What makes retail banks like this such popular dividend stocks in the first place?
There’s more than one answer to this question. These companies have very strong balance sheets, due in part to strict regulatory requirements, which they can use to shower their shareholders with cash.
The likes of Lloyds can choose to plough this in their operations instead, of course, through organic investment or by way of acquisitions. But growth opportunities in the UK banking market is limited, and so paying large dividends is seen as the best way to reward investors.
Retail banks also benefit from stable cash flows they can use to finance these payouts. Interest income on loans like mortgages is broadly stable, even during economic downturns. It’s the same for the fees they charge in other areas like current accounts and payment services.
Strong dividend growth
These qualities remain very much in place today. With a CET1 capital ratio of 13.8%, Lloyds certainly still sits on strong foundations.
With earnings also tipped to steadily increase, City analysts are expecting annual dividends to rocket by double-digit percentages over the next three years:
| Year | Dividend per share | Dividend growth | Dividend yield |
|---|---|---|---|
| 2025 | 3.6p | 13.6% | 3.8% |
| 2026 | 4.16p | 15.6% | 4.4% |
| 2027 | 4.85p | 16.6% | 5.1% |
If these forecasts are accurate, investors can expect strong protection from inflation eroding their income.
So what’s wrong?
Lloyds clearly still has lots of appeal as a dividend stock, then. But is it a company I’d buy myself for passive income? The answer’s an emphatic ‘no.’
At just 3.8%, the bank’s forward dividend yield has slumped from the 6%-plus it was at just two years ago. In my view, there are much better FTSE 100 and FTSE 250 income shares to buy to target both dividend growth and yield.
Legal & General (9% dividend yield), Aviva (5.9%), and Primary Health Properties (7.6%) are three I hold in my portfolio. And I’m confident they’ll outperform Lloyds for dividends over the long term given their enormous market opportunities.
A risk too far
But this isn’t the main reason I’m avoiding Lloyds shares. Following its huge share price gains this year, the bank’s looking massively overvalued in my book and vulnerable to a sharp correction.
A blend of economic stagnation, rising competition, regulatory threats, and falling interest rates pose significant threats to the company. I don’t think this is reflected in Lloyds’ elevated valuation — a forward price-to-earnings (P/E) ratio of 13 times also makes it the most expensive banking stock in the UK.
Like any investor, I need to consider potential share price movements along with dividends. Large and growing cash rewards are great. But they can easily be wiped out if the stock crashes.
Lloyds shares might be worth considering by investors with higher risk tolerance. But I won’t be buying them for my portfolio.
