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Lloyds (LSE:LLOY) shares have dipped in recent months. The UK banking giant was trading above 50p before the US banking fiasco sent shockwaves around the world.
But with the share price falling, and the dividend rising, Lloyds has become something of a dividend giant. At this moment, the FTSE 100 stock offers investors a 5.2% yield.
And it doesn’t stop there. City analysts expect last year’s 2.4p per share total dividend to rise to 2.8p in 2023 and then 3.1p in 2024. At the current price, the forward dividend yield for 2024 will be 6.9%. That’s massive.
But many investors are fearful of banking stocks right now. So should investors make a contrarian investment in Lloyds?
The fear
I’m going to channel legendary investor Warren Buffett here. He famously said to be “fearful when others are greedy, and greedy when others are fearful.”
The Berkshire Hathaway boss tells us to avoid the crowd and explore opportunities that emerge when share prices fall.
That’s certainly the case at this moment. Investors are concerned about the impact of high interest rates and slow economic growth on bad debt.
And yet, conversely, some analysts are suggesting recent results are the best it’s going to get for banks like Lloyds. They’re referring to soaring net interest income and contend falling rates are a problem — I disagree.
The upside
When it comes to impairment charges on bad debt, things are as bad as some anticipated. In 2022, Lloyds took an impairment of £1.5bn, yet this figure was only £200m in the first quarter of 2023.
Don’t get me wrong, I’m still a little concerned about the next few quarters, especially if interest rates go up further. But it’s not the terrible scenario some investors expected.
On the subject of net interest income, falling central bank rates, hopefully starting in H2, will reduce bank margins and interest revenues — that much is clear.
However, I believe there’s a sweet spot for banks. That’s when interest rates sit closer to 2% or 3%.
At these levels, assuming there is no economic meltdown, impairment charges will fall, while interest revenue will remain elevated versus where it has been for much of the last decade.
Incidentally, in the medium term, we can expect Bank of England interest rates to fall to this sweet spot, or somewhere near it.
Buying for dividends and more
If I were to buy 20,000 shares today, it would cost me just over £9,000. I appreciate that’s a sizeable holding for many investors.
For 2023, according to analysts’ forecasts, that holding would provide me with me with £560 in dividends for the year. And in 2024, that figure would rise to £620.
However, I already have a sizeable holding in Lloyds and, right now, I can’t afford another 20,000 shares. But I have been topping up in recent months and that’s not just because of the dividend yield.
Discounted cash flow calculations suggest this bank could be undervalued by as much as 50% — that current trough is an excellent opportunity for investors.
