Is Lloyds Banking Group PLC A Safe Dividend Investment?

LloydsSince the credit-crunch, Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) hasn’t paid a dividend, but the firm intends to restart payments in the second half of 2014.

Recent trading updates seem full of news about a profit recovery, so it’s no surprise that dividends seem set to resume. City analysts following the firm think the new payout will be around 1.27p for the current year, rising to 3.15p in 2015. At the current share price around 76p that means the forward yield is running at around 1.7%, rising to 4.1%.

Is a potential 4.1% dividend yield attractive?

A yield of 4.1% might seem attractive for some firms, particularly those engaged in businesses other than banking, but that’s a low yield for a bank, I’d argue.

If we look at earnings’ growth for Lloyds, we can see that the current year shows an expected step-change to positive territory from the losses of recent years. That’s good, but 8% growth in 2015 is pedestrian, and such predictions signal a return to on-trend normality — Lloyds’ recovery in earnings has essentially happened.

So what does back-to-normal growth look like for a bank? When we see ‘normal’ trading conditions, such as now, it means we are mid-macro-economic cycle. Trading conditions seem set for a benign period without too many economic shocks. Yet the forward-looking stock market will likely keep a lid on its valuation of banks. At least it should do because their profits tend to rise and fall in tune with general economic conditions and profitability could plunge at any time.

Lloyds currently trades on a forward P/E rating of around 9.2 for 2015. In one model for accommodating the cyclicality of bank shares — my favourite — the P/E rating is seen as tending to  fall as profits gradually rise, and as the current macro-cycle unfolds. That means that the dividend yield seems likely to rise.

However, the risk for investors now is that capital attrition could work against income gains to deliver a lacklustre outcome on total returns, despite apparently improving trading. Then there’s the ever-present gun to the head thanks to not knowing when Lloyds will face its next cyclical profit collapse — could the London-listed banks be any more unattractive right now? Surely, there are better income opportunities in other sectors.

What now?

Lloyds continues to sell off its well-performing TSB division as obligated by European Commission State Aid commitments. Meanwhile, the UK government is making progress towards returning Lloyds to full private ownership (PLC status) and has reduced its shareholding to around 25%. That’s sobering news and indicates just how low an out-and-out cyclical company can go.

The firm is rebuilding itself to focus on the UK market and seems set to emerge as a stronger, leaner and more functional financial institution in the end. I’m glad about that, because the bank can then get on with facilitating British economic activity, which underpins my investments in other industries. However, when it comes to searching for long-term investments, I’m lumping banks such as Lloyds into the ‘no’ pile, along with the likes of airlines and other cyclical sectors. Such sectors require a shorter-term approach to investing, in my view.

I’m not keen on Lloyds Banking Group shares just now, and I don’t think I’m the only investor who feels that way.

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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.