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Shares in Lloyds Banking Group (LSE:LLOY) currently come with a 4.11% dividend yield. And the amount the company returns to shareholders has been rising over the last few years.
Investors thinking of buying the stock, however, need to be careful. Banking is a highly cyclical industry and Lloyds is subject to more ups and downs than a lot of other businesses.
Earning a second income
Over the last 12 months, Lloyds has returned 3.33p per share in dividends to investors. That means someone looking for a £1,000 a year second income would need to buy 30,303 shares.
That sounds like a big number – and it is – but Lloyds has the lowest share price in the FTSE 100. At today’s prices, buying that many shares would cost an investor £24,563.
One thing to note is that the bank has been increasing its dividend. A year ago, the firm returned 2.9p per share, so an investor would have needed 34,482 shares to earn the same annual income.
This suggests someone might be able to generate a £1,000 a year second income by buying fewer shares and waiting for the dividend to grow. But this is a risky strategy when it comes to Lloyds.
Banking risks
When things go wrong with banking stocks, the consequences can be spectacular. But I’m not anticipating any major problems for Lloyds in the near future.
In the near term, I think the biggest threat is the potential for falling interest rates. Over the last few years, Lloyds has benefitted from wider lending margins as rates have been higher.
That, however, looks set to reverse in the next few months. So I don’t think investors should count on the firm continuing to grow its dividend the way it has in recent years.
Lloyds, however, is the largest provider of UK current accounts and savings. And that gives it a big advantage over other banks when it comes to long-term profitable lending.
Borrowing costs
Lending is a core source of banking revenues, but issuing loans requires access to capital. And there are two main sources of funds available.
One involves issuing bonds to bring in cash that can then be lent out at higher interest rates. The other is by using funds deposited by customers into things like current accounts and savings.
In general, deposits are a much cheaper source of capital than bonds. This is because banks don’t tend to pay much interest (if any) on current accounts and savings.
That’s why Lloyds having a large base of consumer deposits puts it in a strong position. It means the firm’s loans stand a good chance of remaining profitable even if interest rates fall.
Outlook
Right now, an investor looking for £1,000 a year in passive income from the stock would need 30,303 shares. But if interest rates fall, I expect this number to increase.
Whether or not that’s worth considering depends on a few things. For someone starting from scratch, it’s a lot to invest in any individual company.
For an investor who already has a big portfolio, though, I think it’s worth considering. A strong position in an industry that isn’t likely to go away could well be a formula for long-term success.
