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Why Lloyds’ share price could make it a top dividend buy

Image: Lloyds

Shares in Lloyds Banking Group (LSE: LLOY) have surged ahead of the FTSE 100 over the last year, rising more than 50%. But despite this gain, the Lloyds share price remains under 50p, and the bank’s stock now offers a forecast yield of 4.7%.

As an income investor, I’m tempted to take a bite of this juicy payout. I reckon it could be one of the best dividend shares to buy today. Here’s why.

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Dividend set to grow

The UK’s big banks were placed under dividend restrictions last year. Initially, the regulator banned them from making any payouts. Later on, dividends were restricted to 25% of quarterly profits. Understandably, these restrictions caused Lloyds’ share price to fall.

These limits were put in place to ensure that banks would be able to handle any increase in bad debts or other losses resulting from the pandemic. The Bank of England wanted to make certain there would be no repeat of the 2009 bank bailouts.

The good news is that these restrictions were removed last week. According to the Bank of England, they are “no longer necessary”. That certainly seems true at Lloyds, which reported a profit of £1.4bn last year and an increase in surplus capital last year.

Lloyds’ spare cash is now significantly above its target levels, which suggests to me that shareholders can expect above-average dividend growth over the next couple of years. Broker forecasts support this view, suggesting that the 2022 dividend could rise by as much as 15%.

What could go wrong?

I’m bullish about the outlook for Lloyds. I believe the bank is well positioned to provide reliable dividends. It’s the UK’s largest mortgage lender and also has sizeable credit card and car finance operations. But there are risks.

Firstly, banking is cyclical. Government support schemes prevented a surge of bad debts among businesses and consumers last year. But the UK economy could still fall into recession at some point after these schemes end.

My guess is that Lloyds’ management will take a cautious approach to shareholder returns. They’ll want to ensure the bank can cope with future problems without cutting the dividend again.

A second risk is that unlike most companies, the UK’s big banks aren’t always free to act as they see fit. Last year is a good example — the Bank of England effectively took control of banks’ dividend decisions. This might happen again.

Lloyds share price: too cheap?

Despite these concerns, I think that Lloyds shares offer good value at current levels. This year’s forecast dividend yield of 4.6% is expected to rise to 5.4% in 2022. Both payouts look easily affordable to me.

At a share price of 47p, Lloyds’ shares are also trading around 10% below their book value of 52.4p. I see that as a sign of decent value. If the bank’s performance recovers as expected, I think the stock could support a higher valuation.

On balance, I think Lloyds is attractively priced and should provide reliable, growing dividends over the next few years. I’d be happy to add the shares to my portfolio at current levels.

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Roland Head has no position in any of the shares 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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