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Forget the cash ISA! I’d pick up the Lloyds share price’s 6% yield

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At the time of writing, the Lloyds (LSE: LLOY) share price supports a dividend yield of just over 6%, four times higher than the best cash ISA rate currently available on the market.

In some respects, this difference in returns makes sense. After all, owning shares is generally riskier than holding cash — you should always have some cash savings at hand to meet any unforeseen expenses.

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However, today I am going to explain why having too much cash can actually damage your financial situation, and why the Lloyds share price could be the best investment to wake up your money in 2019.

Inflation pains

One of the most significant threats investors face around the world today is the scourge of inflation. Inflation is a silent killer. You don’t really notice it eroding your wealth. But it is, slowly and surely. 

Since 2010, inflation has added around 26% to the price of goods and services in the UK. In theory, interest rates should offset this price growth. Unfortunately, for the past decade, they haven’t. 

While inflation has averaged around 2% per annum, the UK base rate has remained depressed at 0.5%. The latest inflation data shows the percentage of CPI at 2%, implying that a cash ISA with an annual interest rate of 1.5% is yielding an inflation-adjusted return of -0.5% every year.

In comparison, the Lloyds share price’s 6% dividend yield provides investors with a 4% inflation-adjusted return, and that’s excluding capital growth.

Exciting growth ahead

Income is only part of the reason why I would buy the Lloyds share price over a cash ISA. I think there’s also a strong chance that the stock’s value could rise by at least 6% per annum for the foreseeable future, yielding total returns for investors of as much as 11% per annum before adjusting for inflation.

I’ve picked 6% as my capital return target because I believe that over the long term, the company’s share price should rise in line with earnings growth. 

Over the next two years, City analysts reckon earnings will grow around 13% per annum (from 2017’s level). I’ve cut this growth target in half to give a conservative estimate of earnings growth and potential capital gains.

Undervalued 

At the same time, the stock is also trading at what I believe to be a discount valuation. The shares are currently changing hands at a forward P/E of 7.5, which is around the same as the UK banking industry average. But it’s significantly less than some of the bank’s international peers. The US banking sector, for example, is trading at an average P/E of around 10.

Lloyds is close to being the most profitable and efficient bank in the UK, and I reckon it deserves a premium valuation as a result. A P/E of 10 wouldn’t be, in my opinion, too demanding. We will probably have to wait until Brexit is finalised before investors are willing to pay more for the shares, as uncertainty is weighing on all UK equities right now. But when confidence returns, Lloyds’ low valuation leads me to believe that the stock will jump.

So overall, Lloyds’ inflation-busting dividend yield, growth potential and discount valuation are all reasons why I would buy the shares with my hard earned money, rather than stashing it away in a cash ISA and seeing the value eroded by inflation.

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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.

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