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Last year, the main street bank Lloyd's (LSE: LLOY) increases its annual payout to shareholders by a fifth. That 20% increase in Lloyds' dividend means that, at the current share price, the stock is yielding 6%.
If we see larger dividend increases, the potential dividend yield could be even higher than that.
Where will things go from now on? Could now be the right time to invest in the bank?
Smaller but still large increase
This year's interim dividend increased at a slower rate than in the previous 12 months. Still, the increase was 15%. That's considerable.
We don't know what will happen throughout the year. But if we go by the provisional payment, I wouldn't be surprised to see a 15% increase.
That would mean a final dividend of around 1.84 pence per share. This would mean a potential return of around 6.6% at the current share price.
Potential for more
But the bank could decide to continue increasing the annual dividend at 20% per year if it wanted to. I don't expect that to happen. If it were in the cards, I think it would have been noted more clearly in the interim results.
But it is a possibility. Last year Black Horse Bank made a pre-tax profit of £6.9bn. Its dividend cost £1.5bn. In other words, if profits continue at the same level, the cost of Lloyds' dividend could grow 20% a year over the next eight years and still be covered by pre-tax profits.
On top of that, a large share buyback program means there are now fewer shares outstanding. Therefore, increasing the annual dividend per share this year by 20% would not actually require 20% more spending than last year.
Looking to the future
Even now, Lloyds' dividend is lower than before the pandemic. Therefore, not only could the company afford a higher payout, but doing so would simply return it to what it used to be.
But while I expect the dividend to reach its 2018 level again, I don't expect annual dividend increases of 20% or even 15% in the coming years. This is due to several reasons.
As the share buyback shows, the company is generating a lot of extra money right now, but it only wants to use some of it to increase the dividend.
Lloyds has advantages including a proven business model, strong brands and a large customer base. However, with a weak economy, I see the risk of mortgage defaults increasing. With its large portfolio of mortgage loans, that could hit Lloyds' profits. That could mean dividend coverage falls from its current very high levels.
Lloyds has cut its dividend in the past, most recently during the pandemic, and could do so again if business gets tough.
From an income perspective, Lloyds' 6% dividend yield stands out to me. But I prefer to invest in other businesses that I now believe may be less affected by the weakness of the real estate market. So I have no plans to invest in the bank.
