There’s no denying Lloyds Banking Group (LSE: LLOY) is a popular share among UK private investors, and so far in 2024 the price has done well.
However, most are probably attracted by the big dividend on offer. With the stock in the ballpark of 59p, the forward looking yield for 2025 is a meaty 5.8%. At first glance, that kind of income stream would sit well in my portfolio.
A round trip for dividends
However, the forecast shareholder payment for 2025 is around the level of 2019’s. But that’s despite five years of impressive double-digit percentage increases in the dividend since 2020. So what’s gone wrong?
The problem is that the Lloyds directors took an axe to shareholder payments when coronavirus hit. In fairness, the Prudential Regulation Authority (PRA) requested the boards of the large UK banks to suspend dividends and share buybacks in 2020.
Covid 19 was scary and full of unknown outcomes, and the regulators had been scarred by the dramatic financial collapse in the banking sector in 2007/08. So they weren’t taking any chances.
So far, so understandable. But what Lloyds didn’t do is fully restore dividend payments soon after the lockdowns had eased. Instead, the directors took the opportunity to rebase payments lower.
That move speaks volumes about their view of how vulnerable the Lloyds business is to general cyclicality in the banking sector. Bank businesses can suffer a lot when economies weaken, leading to plummeting earnings, cash flows, share prices and dividends.
Cyclically challenged
In fact, cyclicality is the biggest risk with Lloyds shares, as I see it. The business has been posting high earnings for several years now, but that’s unlikely to go on for ever. At some point, there’ll probably be a business turndown as the cycle moves through its usual multi-year fluctuations. If and when that happens, it will be easy to lose money on Lloyds shares.
But Lloyds could yet move higher. Earnings may rise and the dividend might increase for years ahead. If we see an enduring period of growth and prosperity for the UK economy, Lloyds shareholders could do well in the years ahead, whether they’re investing for income, growth or both.
However, that cyclical risk is a good reason for the stock market to keep the valuation pegged low. After all, how else can the market try to account for all the increased uncertainty with such a cyclically sensitive business?
For that reason, I don’t see Lloyds as a FTSE 100 bargain. To me, it looks fairly priced despite its single-digit price-to-earnings rating and high-looking dividend yield.
Nevertheless, I can see why investors are attracted to the stock. But if I held it, rather than treating it as an income play, I’d consider it firstly as a cyclical investment. That means keeping it on a short leash with one hand on the ejector-seat ready to exit at the first sign of trouble!
This post was originally published on Motley Fool
