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Banks like it Lloyds Banking Group (LSE:LLOY) can be great stocks to buy for a solid passive income.
The interest from their lending activities generates a steady and significant cash flow that they can then distribute to their shareholders, either through a large and growing dividend or through share buybacks.
Lloyds' dividend has risen every year since the height of the Covid-19 crisis, and City analysts expect it to continue to grow until at least 2026.
As a result, the market-beating dividends for which Lloyds is famous have risen steadily over the period, as shown in the table below.
| Year | Dividend per share | Dividend growth | Dividend yield |
|---|---|---|---|
| 2024 | 3.3p | 20% | 5.6% |
| 2025 | 3.48p | 6% | 5.9% |
| 2026 | 4.04p | 16% | 6.9% |
But fixed-income investors should consider the realism of current dividend projections before buying. They should also consider weighing up the prospect of higher cash rewards against the potential for a stagnant (or even falling) Lloyds share price.
Here is my opinion on the FTSE 100 Index bank.
In very good shape
The first part of my assessment is quite encouraging. I think Lloyds is in very good shape to pay the huge dividends that analysts expect.
Over the next three years, Black Horse Bank's dividends will be covered by expected earnings by 2 to 2.2 times.
Both figures are around the accepted safety benchmark of 2x or more. This is important given that the UK's economic outlook remains highly uncertain, which in turn poses a threat to banking sector earnings.
Investors can also take comfort from Lloyds’ healthy balance sheet. In June, its common equity tier 1 (CET1) ratio was a solid 13.7%. This means the bank could continue to pay out big dividends even if profits are disappointing.
Great risks
It's fair to say that the dividend outlook at Lloyds is pretty encouraging, but does this necessarily make the bank one of the best stocks to buy? I'm not convinced.
When investing, I look for companies that can pay a passive income. and Offering healthy capital appreciation over time. And I'm not sure the bank meets my criteria.
Lloyds' share price has risen more than 40% over the past year, but is still almost 25% cheaper than it was 10 years ago.
And I think it could go back down soon as conditions get tougher.
First, the boost that higher interest rates have provided to margins is already fading. Lloyds’ net interest margin (NIM) sank 24 basis points in the first half, to 2.94%. And things will get even tougher if (as expected) the Bank of England steadily cuts interest rates over the next year.
Their margins are also under attack as rival banks ramp up their operations. Traditional banks are being forced to increasingly cut borrowing costs or raise savings rates to stop losing customers to the likes of Revolut. And so far, this has had only limited benefit.
Cheap for a reason
The stock is currently very cheap. In addition to having those great dividend yields, the bank trades at a price-to-earnings (P/E) ratio of 9 times.
However, in my view, this low valuation accurately reflects the risks the bank poses to investors. I would rather buy other dividend-paying stocks today.