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Could the Lloyds dividend be a growing source of second income?

Man putting his card into an ATM machine while his son sits in a stroller beside him.
Image source: Getty Images

In the week that Lloyds (LSE: LLOY) boosted its annual shareholder payout by 20%, many investors will be looking forward to getting a juicier payment from the bank than before. So might buying the shares now give me a chance to grow my own second income, thanks to a surging Lloyds dividend?

Lloyds ex-dividend date

The way that dividends work, they are first declared before a share goes “ex-dividend”. In this case, the ex-dividend date is 13 April. So I have over a month in which, if I bought shares and continued to hold them, I would receive the payout declared this week.

The final dividend is 1.6p per share, making the full-year payout 2.4p per share. At the current Lloyds share price, the annual dividend yield is therefore 4.6%.

On its own though, I would need to invest a lot of money to generate a substantial second income. With a 4.6% yield, earning £23,000 a year would require me to invest half a million pounds. I do not have that money and even if I did, I would not invest it in only one company.

However, might there still be a more modest place for the black horse bank in my portfolio?

Strong dividend growth

Let’s say I put £10,000 into the shares today. I would be on course to earn £460 over the coming year, thanks to the Lloyds dividend.

But what if the company continues to raise its dividend by around 20% a year?

In that case, 10 years from now, the payout will be almost 15p per share. That is equivalent to a yield of around 29% at today’s price. So my £10,000 worth of shares today ought to be generating almost £3,000 in second income each year a decade down the line.

That certainly sounds attractive – but is it likely to happen?

Lloyds dividend outlook

I do not think so. Although the bank raised its dividend substantially this week, it still remains well below its pre-pandemic 2019 level.

Raising a dividend 20% year after year is like folding a piece of paper again and again. It gets harder to do each time, because the baseline rises.

For now, Lloyds is only paying out a fraction of post-tax earnings as dividends, around 29% last year. But that percentage could rise fast if the Lloyds dividend grows rapidly.

The year before last, for example, earnings per share were 7.5p and the dividend per share was 2p. Last year the dividend rose to 2.4p per share. But earnings slipped to 7.3p per share. That is still a comfortable coverage level for now. But in the long run, if dividends rise steeply and earnings do not (or fall, as happened last year), strong dividend growth becomes unrealistic. Indeed, there could be a cut in such a situation.

I’m not buying

Lloyds has a strong position in UK banking and remains hugely profitable. But could last year’s decline in earnings be a sign of things to come?

I see a risk that a weak UK environment could lead to higher loan defaults, damaging the bank’s profitability. In its results, the bank flagged “risks from a higher inflation and interest rate environment”.

I will look elsewhere for a growing second income rather than investing in Lloyds.

The post Could the Lloyds dividend be a growing source of second income? appeared first on The Motley Fool UK.

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C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2023