Does Lloyds Banking Group PLC Pass My Triple Yield Test?

Like most private investors, I drip feed money from my earnings into my investment account each month. To stay fully invested, I need to make regular purchases, regardless of the market’s latest gyrations.

However, the FTSE’s gains mean that the wider market is no longer cheap, and it’s getting harder to find shares that meet my criteria for affordability.

In this article, I’m going to run my investing eye over Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US).

The triple yield test

Today’s low cash saving and government bond rates mean that shares have become some of the most attractive income-bearing investments available.

To gauge the affordability of a share for my income portfolio, I like to look at three key trailing yield figures –the dividend, earnings and free cash flow yields. I call this my triple yield test:

Lloyds Banking Group Value
Current share price 83p
Dividend yield 0%
Earnings yield -1%
Free cash flow yield -28%
FTSE 100 average dividend yield 2.7%
FTSE 100 earnings yield 6.0%
Instant access cash savings rate 1.5%
UK 10yr govt bond yield 2.8%

Lloyds’ performance over the last twelve months was uninspiring, but its performance during the first half of 2013 was more encouraging, as the bank reported earnings of 2.2p per share and an increased net interest margin of 2.01%, one of the best in the sector.

Extrapolating this performance forwards, analysts’ consensus forecasts for Lloyds’ full-year 2013 results are for earnings of 5.3p per share, which equates to an earnings yield of 6.4%.

The dividend question

Of course, the real question for Lloyds investors — and one of the main factors in the bank’s 60% share price rise over the last twelve months — is whether the bank will declare a dividend in 2014.

The City’s experts are firmly of the opinion that Lloyds will get permission to restart dividend payments this year, and are currently forecasting a 2.5p payout for 2014, giving a prospective yield of 2.9%.

Although this is lower than the yield available from peers such as Barclays and HSBC Holdings, Lloyds CEO António Horta-Osório raised investors’ hopes last year when he said that his target was to pay out 70% of earnings as dividends by 2015, hinting at the potential for rapid dividend growth over the next couple of years.

Is Lloyds a buy?

Lloyds now trades at 1.6 times its tangible net asset value, compared to just 0.96 times for Barclays and around 1.35 times for ultra-safe HSBC.

Although a return to profit is likely, many potential pitfalls remain for Lloyds. I expect the bank’s shares to underperform the market this year, and rate Lloyds as no more than a hold.

Despite my caution, it's worth noting that Lloyds' most recent results suggest it has a significant competitive advantage over Barclays and Royal Bank of Scotland in two key areas.

I can't reveal all the details here, but you can find out more in "The Fool's Guide To Investing In Banks", which contains a six-point competitive analysis of all five major UK banks, and reveals some surprising contrasts.

This free report is an essential read for any investor with an interest in UK banking stocks -- for instant access to your copy, click here now.

> Roland owns shares in HSBC Holdings, but does not own shares in any of the other companies mentioned in this article.