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Lloyds shares: are they worth buying for the dividend?

Lloyds Bank (LSE: LLOY) shares are popular among income investors as they offer a high dividend yield. Currently, the FTSE 100 stock offers a prospective yield of a spectacular 6.4%, which is no doubt appealing when you consider the low interest rates offered on savings accounts.

However, as experienced investors know, there’s more to dividend investing than just yield. When investing for income, it’s also important to analyse dividend coverage and dividend growth. You want to make sure that the dividend is sustainable and that it will provide protection against inflation going forward. With that in mind, let’s take a closer look at Lloyds shares to see how the dividend stacks up.

Solid coverage

Looking at dividend coverage, Lloyds’ dividend appears to be relatively safe. As the table below shows, the bank’s dividend coverage ratio was 1.71 last year and this year, analysts forecast a ratio of 2.28.

  FY2017 FY2018 FY2019E
Earnings per share (p) 4.40 5.50 7.67
Dividend per share (p) 3.05 3.21 3.36
Dividend coverage ratio 1.44 1.71 2.28

Generally speaking, a dividend coverage ratio above two is good. This indicates that earnings comfortably cover the dividend and that there’s a low chance of a dividend cut. Overall, I’m happy with the level of dividend coverage that Lloyds offers.

Healthy dividend growth

Examining dividend growth, I also like what I see. Over the last three years, Lloyds has increased its payout by 43% from 2.25p to 3.21p, which is an impressive level of growth.

  FY2015 FY2016 FY2017 FY2018 FY2019E FY2020E
Dividend per share (p) 2.25 2.55 3.05 3.21 3.36 3.53

Looking ahead, analysts currently forecast dividend increases of 5% this year and next year. Clearly, the trend is up, which is what you want from a dividend-investing perspective. If the payout keeps rising, it should provide inflation protection.

Risks

Moving on to risks, is there anything that could impact Lloyds’ ability to pay its dividend?

In Lloyds’ case, there are a number of risks that do concern me. For starters, the bank is highly exposed to the UK economy meaning a Brexit-related economic downturn could hit profits. This could threaten the dividend.

In addition, competition from FinTech companies is another issue to consider. Today, digital banks and FinTech start-ups are completely overhauling the banking industry and if the traditional banks aren’t careful, they could lose customers. This could potentially impact profits and dividends over the long run.

Valuation

Finally, turning to the valuation, Lloyds shares currently trade on a forward-looking P/E ratio of a low 6.8. That’s less than half the median FTSE 100 forward P/E of 14.2. In my view, that valuation is attractive.

Good dividend stock?

All things considered, I think Lloyds shares look attractive from a dividend-investing perspective. The yield is appealing, dividend coverage is healthy, and the payout looks set to grow in the years ahead.

That said, given the uncertainty over Brexit and how this will impact the UK economy, there are other dividend-paying companies that I’d buy before Lloyds at the moment.

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Edward Sheldon owns shares in Lloyds Banking Group. 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.