Will Lloyds Banking Group PLC Really Pay A 5% Dividend In 2016?

With interest rate rises likely to be slow and steady in the coming years, dividends are set to remain of paramount importance for most investors. Certainly, a return to the historic norm of interest rates of 4%+ could be many years away, with such a level unlikely to be reached in the current parliament.

So investors are likely to maintain their relatively high demand for income stocks and one company which could fit the bill over the medium term is Lloyds (LSE: LLOY).

Clearly, Lloyds’ dividend is not making headlines at the present time, since the bank is about to embark on a retail offering of its shares. Of greater significance to potential purchasers is the 5% discount to the stock’s market price, as well as the “buy ten shares and get one free (after a year)” offer, which is likely to resonate well with the public.

However, Lloyds also has very appealing income prospects. Its yield of 3.2% may be lower than the FTSE 100’s yield of around 3.7%, but in 2016 Lloyds is expected to yield as much as 5.1%. This would take it into the upper echelons of the FTSE 100’s dividend stock space and could cause investor sentiment to rise sharply over the medium term.

Such a large rise in a company’s dividend yield must always be carefully looked into. In some cases it can be a signal that it is overextending itself and failing to reinvest sufficiently in future growth opportunities, favouring the reward of shareholders in the short run over longer term considerations.

In Lloyds’ case, though, it appears to be a very affordable dividend, since it would equate to a payout ratio of just 49%. With the bank’s financial performance and financial stability on a much stronger footing than it was even a couple of years ago, a payout ratio of that level appears to be extremely prudent. In fact, Lloyds is rumoured to be targeting a payout ratio of around 65%, according to comments apparently made by its CEO. Were it to pay out 65% of profit as a dividend next year, Lloyds’ shares would be yielding 6.8%.

Of course, that 6.8% figure does not take into account the growth potential which the bank offers over the medium term. Its UK-focus is likely to be hugely beneficial in the coming years as the economy continues to benefits from rising disposable incomes in real terms as well as a highly accommodative monetary policy. As such, Lloyds’ dividend yield could push past 7% over the medium term, thereby making it a very enticing income play.

Certainly, buying Lloyds is not without risk and, while the sale of non-core assets and cost cutting have led to a stronger balance sheet and lower cost:income ratio of 48%, it remains a part-nationalised business which is still not back to full financial health. But, for long term investors, now represents an excellent time to buy a slice of Lloyds, with its income appeal being very high.

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Peter Stephens owns shares of Lloyds Banking Group. 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.