Its been a frustrating year for investors in Lloyds (LSE LLOY) (NYSE: LYG.US), with shares in the bank falling by 2% since the turn of the year. Even the FTSE 100, which has also been a massive disappointment in 2014, has beaten Lloyds. It is up 1% year to date. However, Lloyds has huge potential; not only in terms of capital gains prospects, but also as a top notch income play. Heres why Lloyds could become the must-have dividend stock over the next few years.
Clearly, the key reason for Lloyds becoming a sought after income stock is likely to be a turnaround in its profitability. Indeed, Lloyds is set to deliver a bottom line that is in the black for the first time since 2009. However, it doesnt appear to be a flash in the pan, as Lloyds is due to increase earnings by an impressive 8% in 2015, which should allow the bank to restart dividend payments this year.
A Changing Payout Ratio
However, the real potential for Lloyds as an income play rests with the banks payout ratio. In 2014, Lloyds is expected to pay 1.3p per share as a dividend. This equates to a yield of just 1.7%, which is only just over half the FTSE 100s yield. This dividend, though, represents just 18% of Lloyds forecast profit for full year 2014 and this shows that there is huge scope for the bank to increase the proportion of profit that it pays out as a dividend.
Indeed, management at Lloyds has stated that is aiming for a payout ratio of around 65% by 2016. Certainly, this is a goal: it may not be met, but even if a fairly large margin of safety is applied, it is clear that Lloyds payout ratio is set to expand rapidly. For instance, in 2015, Lloyds is forecast to have a dividend of 3.2p, which works out at a payout ratio of 39%. Assuming the share price of Lloyds stays where it is, this means that it could yield 4.2% as early as next year and have the potential to go much, much higher.
As well as having huge potential as an income stock, Lloyds also offers good value for money at its current share price. For instance, it trades on a price to earnings (P/E) ratio of 10, which is well below the FTSE 100s P/E of 13.7. As a result, it could prove to be a stunning income play in future years and also has the scope for upward adjustments to its rating, making Lloyds a potential winner.
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Peter Stephens owns shares of Lloyds Banking Group. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.