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The dividend yield indicates how much money investors will receive from their investment in the form of relatively regular — often biannual — payouts. This is why stocks that pay a dividend are favoured by investors hunting passive income.
However, investors have to be wary of some fairly common pitfalls when investing for dividends. The first one is recognising that dividend yield for the past year isn’t always representative of the dividend yield investors will receive over the coming year.
For example, the Hargreaves Lansdown platform currently suggests housebuilder Crest Nicholson pays a 10.7% dividend yield. But that’s based on last year’s payout, and the dividend forecast this year almost certainly won’t amount to that.
So, what’s the dividend stock I’m referring to in the title? Well, it’s Lloyds Banking Group (LSE:LLOY), a dividend stock hiding in plain sight.
The dividend forecast is more than noteworthy
Lloyds is potentially overlooked as a dividend stock. However, the yield has long been above average for the FTSE 100, and analysts have a promising forecast for dividend payments.
For 2024 — the current financial year — the expected dividend yield is 5.6%. It is forecasted to rise moderately to 5.9% in 2025. However, analysts expect a significant jump to 6.9% in 2026, meaning that every £100 invested will return £6.90.
For many investors, the ideal investment provides steady income, shows consistent growth, and comes from a stable sector. Lloyds checks all these boxes, positioning itself as a potentially wise choice for those looking to bolster their income streams.
What’s more, Lloyds’ dividend looks well covered by earnings, providing confidence in its sustainability and growth potential. The bank’s payout ratio is expected to increase from 36.8% in 2023 to 47.4% in 2024, and then to 54.9% in 2025, before moderating to 44% in 2026.
Even at its peak, this payout ratio indicates that Lloyds is retaining a significant portion of its earnings. This should allow it to maintain its dividend payments even if it faces temporary setbacks. This conservative approach to dividend distribution suggests that the projected dividend growth through 2026 is both achievable and sustainable.
It may even indicate that the dividend can push higher towards the end of the decade.
A promising opportunity
Investors should also be buoyed by the supportive trends within the banking sector. Slowly falling interest rates mean that banks can gently unwind their hedging activities, replacing low-yield fixed investments with higher yield bonds.
This hedging strategy generated £1.9bn in income in the first half of 2024 and given that Lloyds’s hedge are over a longer duration than other banks — 3.5 years on average — this should remain a supportive trend for some time.
And this, combined with other factors including improved loan growth, is why analysts claim the stock is undervalued by nearly 20%.
However, it would be unwise not to acknowledge investors’ concerns about potential fines relating to mis-sold motor insurance. Lloyds put aside £450m to address potential costs, but RBC analysts believe the final sum could climb as high as £3.9bn. It’s not as big as the PPI scandal, but it’s certainly large.
Nonetheless, I believe Lloyds is an attractive opportunity for dividend and value investors alike to consider. If UK banks weren’t already well represented in my portfolio, I’d buy more.
