Income-minded investors are always on the lookout for companies that not only pay a steady, increasing dividend, but also have room for to keep increasing those payouts as time goes on.
Thus, investors tend to look at a few metrics, including “dividend payout ratio” — what percentage of a company’s earnings are paid out in dividends. The lower the payout ratio, the more room a company theoretically has to increase its dividend without breaking the bank.
Granted, a high payout ratio signals that a company very much has its investors in mind, but don’t be fooled if the number is too unrealistic. What’s “too unrealistic”? Honestly, situations vary from company to company, but a couple good numbers to keep in mind is that the historical average for the S&P 500 is between 40% to 50%, and the current payout ratio is around 31.5%. Financials in specific pay out around 22% of their earnings in dividends.
So, when London-based financial services company Lloyd’s (LYG) announced it will target a 70% payout ratio within the next three years, perhaps it should raise a few eyebrows.
Indeed, Lloyd’s announcement should come with even more skepticism considering this would come amid the resumption of a dividend — one that was suspended in 2008 — by a company that has lost more than $4.5 billion in the past three years and underwent a government-sponsored restructuring similar to that of U.S. banks.
Frankly, I think investors targeting income in the financial sector have a couple better options.
Perhaps the two best examples for income investors are Wells Fargo (WFC) and JPMorgan Chase (JPM). Both have not only put together strong earnings growth during the past three years — while shoring up their balance sheets — but they’ve already made the step of improving their dividends without taking on huge payout ratios.
Wells Fargo: WFC has increased its dividend sixfold since the beginning of 2011, from its Great Recession payout of 5 cents to 30 cents currently. Wells Fargo also pays out less than the S&P 500 in earnings at just 27% of profits. Meanwhile, WFC is just coming off a boffo quarter in which it earned a record $5.5 billion. WFC currently yields 2.7%.
JPMorgan: JPM also has come a long way from its Recession-lessened 5-cent payout, which lasted until early 2011, raising its dividend some 760% to its current 38 cents, which yields 2.7% on current prices. JPMorgan pays out even less of its earnings (20%) in dividends, and it too enjoyed a great Q2 in which it logged a 30% gain on the bottom line.
None of this is to say Lloyd’s will be a dividend failure, but let some proof show in the pudding before you dip in and consider getting your financial-sector dividends elsewhere until then.
Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing, he did not hold a position in any of the aforementioned securities.