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One of the reasons I previously bought shares in Lloyds (LSE: LLOY) was because of the passive income potential they seemed to offer. Looking at them today, they again seem attractive from this perspective.
The Lloyds yield is already a tasty 5%. But the dividend last year grew 20%. Not only that, the company could afford a much bigger dividend. Last year, the bank spent £1.5bn paying out ordinary dividends to its shareholders. But its post-tax profit was £5.6bn. That means that Lloyds could have tripled its dividend and still been able to afford the payout.
With that seemingly huge dividend potential, ought I to buy Lloyds shares for my portfolio?
At one point I would have answered that question positively and indeed I then bought Lloyds shares. Since then, however, I have sold them. So, what changed?
Several things unnerve me about Lloyds’ approach to dividends.
They remain far below where they stood before the financial crisis, but also beneath even their pre-pandemic level despite those mammoth profits. Meanwhile, the company is spending billons of pounds buying back its shares. Despite the 20% annual dividend increase, it seems to me that shareholder payouts are just not a high priority for the company’s board.
But the bigger concern that has led me to rethink my previous bullishness on Lloyds is a deteriorating economic outlook. That has become more obvious in the past couple of months, with US bank failures and the sudden takeover of Credit Suisse.
So far that banking crisis has had little impact on UK banks. Lloyds has a strong brand, large customer base and hugely profitable business model.
But the crisis shows once more how a sudden shortfall in confidence can hurt a bank badly. We saw that in the UK during the financial crisis.
Since then, capital requirements have been tightened. Nonetheless, as an investor I am wary about buying any bank shares right now. Instead I am waiting to see what the landscape looks like once the global economy returns to strong growth mode once more.
My take on Lloyds
That means that I will not be buying Lloyds shares for my portfolio again any time soon.
Its focus on the UK is both a strength and a weakness. At a time of ongoing uncertainty for banks globally, I think it could help insulate Lloyds from problems in overseas markets.
But it also means that the UK’s biggest mortgage lender is highly sensitive to the economic performance of its home market. With an unclear outlook for UK housing prices and inflation eating badly into household budgets, I see that as a risk to profits.
On paper, Lloyds shares look cheap. But that was true five years ago and, since then, they have lost 26% of their value.
The buyback programme should lead to fewer Lloyds shares in circulation. That could boost earnings per share even if total profits fall slightly.
But I am not persuaded by the outlook for banks right now. Lloyds’ seemingly ambivalent attitude towards its dividend scares me off as a potential investor. I have no plans to buy, despite the tempting dividend potential.