UK investors are spoilt for choice when it comes to dividend stocks. The FTSE 100 contains a number of companies that have yields of 4% or more. Yet some dividend stocks are better than others. Many high-yielding ones such as Royal Dutch Shell and HSBC Holdings have frozen their dividends in recent years, meaning that income investors are losing purchasing power to inflation. Others have very low dividend coverage. This means that their payouts might be at risk of a cut. For this reason, it pays to be selective when picking dividend stocks.
With that in mind, today I'm revealing one of my top picks for 2018. This one offers both a fantastic yield now as well as potential for strong dividend growth.
The stock I'm referring to is Lloyds Banking Group(LSE: LLOY). Some readers may be surprised that I rate Lloyds so highly. After all, the bank doesn't have the impressive dividend track record of other stocks such as Diageo or British American Tobacco.
Lloyds ran into trouble during the Global Financial Crisis and was forced to cut its dividend. For several years, it paid no dividend at all. That's not what you want as a dividend investor. However, times have changed. Lloyds now looks like a healthier outfit than it was in the past. It has simplified its structure, and now just focuses on banking basics. Conduct charges, which have reduced profitability in recent years, are diminishing. As a result, I believe Lloyds now offers significant dividend potential. Here's why.
Lloyds resumed its dividend payment in 2014 with a 0.75p per share payout. Since then, it has registered two consecutive increases, paying out 2.25p and 2.55p in 2015 and 2016 respectively. It has also paid two special dividends in this time as well.
For 2017, City analysts currently expect a payout of 4.1p. That's a strong yield of 6.2% at the current share price.
Potential for dividend growth
While many other high-yielding FTSE 100 stocks look susceptible to dividend cuts, Lloyds doesn't. In fact, analysts expect the bank to hike its payout again in 2018, to around 4.59p per share. That takes the prospective yield to an amazing 6.9%.
And these payouts are anticipated to be well covered by earnings. Analysts forecast earnings of 7.95p and 7.24p this year and next, resulting in dividend coverage ratios of 1.95 and 1.57.
Not only does Lloyds' dividend yield look attractive, but so does its valuation. On this year's earnings forecast of 7.95p, it trades on a P/E of just 8.4. With the FTSE 100 index trading at an average forward P/E of 15.2, the bank looks very cheap in comparison.
Of course, the shares are not without their risks. It's important to remember that the bank is highly exposed to the fortunes of the UK economy. And let's face it, Brexit has thrown up a great deal of uncertainty. Lloyds' low P/E suggests to me that many investors have written the UK off as a basket-case.
Yet for long-term investors, I believe it offers an attractive the risk-reward proposition right now. Neil Woodford agrees and recently stated that the bank is "one of the most attractive plays in the UK large-cap space."
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Edward Sheldon owns shares in Lloyds Bank, Royal Dutch Shell and Diageo. The Motley Fool UK has recommended Diageo, HSBC Holdings, Lloyds Banking Group, and Royal Dutch Shell B. 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.