While much of the focus in recent months has been on the potential for an improving global economic outlook, the reality is that investors could face a major threat in the coming months. The rate of inflation in the UK has already reached 2.3%, and is forecast to move higher during the course of the next couple of years.
In such a scenario, shares which are able to offer relatively high yields and fast-growing dividends could prove highly popular. While a rather surprising income play due to its troubled past, Lloyds(LSE: LLOY) could prove to be one of the very best income stocks over the coming years.
With the FTSE 100 currently yielding 3.7%, Lloyds has an above-average yield. It currently stands at 3.8% and could therefore be considered attractive to income investors. However, the real appeal of the bank for long-term investors is its potential to increase dividends per share at a rapid rate in future years. Part of the reason for this capacity is the bank's payout ratio of 54%, which is expected to rise to as much as two-thirds of earnings over the medium term.
This means that the bank's dividends are expected to rise at an annualised rate of 27.6% during the next two years. This puts the stock on a forward yield for 2018 of 6.2%, which puts it among the highest-yielding shares in the FTSE 100. Beyond 2018, there is more scope for dividend growth due to the possibility of an even higher dividend payout ratio.
Lloyds could also raise dividends at a significantly faster pace than inflation because of its improved financial standing. While other banks are now seeking to make headcount reductions, reduce the size of their management teams and dispose of non-core assets, Lloyds has already been through a lengthy and challenging process of change. The reason for this could have been the incredibly difficult position in which it found itself after the acquisition of HBOS and the credit crunch. They decimated its balance sheet and severely hurt its income statement.
These difficulties have led to an aggressive approach which has meant redundancies and other cost-cutting measures have been the major focus of the bank in recent years. Today, though, it is relatively efficient and according to its first quarter results, it is making further progress. Therefore, it seems to be better-placed than many of its UK-focused peers to survive the potential challenges which Brexit may throw up. As such, it could be argued that Lloyds offers a relatively stable and resilient income outlook.
Share price potential
This income appeal could mean that Lloyds delivers a gradually rising share price over the medium term. It has traded under 70p for much of the last year, but in future it could move above and beyond that price level. Therefore, even growth investors should give the bank a much closer look, because it has the potential to deliver capital growth and a high income return in the long run.
Peter Stephens owns shares of Lloyds Banking Group. The Motley Fool UK has recommended Lloyds Banking Group. 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.