Shares in Lloyds (LSE: LLOY) have taken a hammering over the past few weeks as investors are becoming increasingly concerned about the impact Brexit might have on the bank.
Uncertainty prevails because, as of yet, we still don’t know what very final deal (if any) will emerge and how it will impact the UK financial services sector.
However, I reckon that no matter what is agreed (or not agreed), over the long term, Lloyds will prove itself to be an excellent income investment, and the recent volatility could be a fantastic opportunity to buy.
Here are the three reasons why I think investors should ignore the short-term noise and buy Lloyds for the long term today.
Lloyds is the UK’s largest mortgage lender, which is both good and bad news for investors. On the one hand, the bank is exposed to the UK housing market. On the other hand, interest income from mortgages is hugely predictable and lasts for decades. What’s more, most borrowers are unlikely to default as, if they do, they risk losing their homes.
As we saw in the last financial crisis, if home prices fall rapidly and the devastation is widespread, banks will suffer. But banks have come along way since 2007, they now hold much more capital to cushion against defaults. Also, Lloyds no longer has an extensive portfolio of toxic derivatives on its balance sheet which could destabilise the business.
All in all, I reckon Lloyds’ massive mortgage portfolio gives the bank a predictable income stream that will help it maintain its dividend
If there is no significant impact on the UK economy after Brexit, and business carries on, as usual, Lloyds has plenty of money available to return to investors.
Analysts believe the bank is set to return £4.5bn of capital to shareholders next year via a higher dividend and a share buyback of almost £2bn. These numbers suggest Lloyds’ dividend yield will hit 6.1% in 2019.
There’s plenty of room for growth in the years after as well. Based on current forecasts, the distribution for 2019 will be covered 2.2 times by earnings per share. On top of this, the group’s common equity tier one ratio rose to 14.6% in the third quarter, far above what is required by regulators.
So, as long as the business does not suffer any sudden shocks, the numbers point to higher cash returns in the near future.
In my opinion, Lloyds is one of the FTSE 100’s best income stocks and for this reason, I think the best way to own it is in an ISA.
Under current plans, any dividend income over £2,000 a year will be taxed to 7.5%, meaning that any distributions will be taxed twice, once at the corporate level and then once at the personal level. By holding Lloyds in an ISA, you can avoid the extra 7.5% dividend tax.
This 7.5% might not seem like much but over the long term, the extra income will really add up, and the extra income will help smooth out any short-term price volatility.
Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.