Should I buy Lloyds shares for the 6.5% dividend yield?

Lloyds Bank (LSE: LLOY) shares continue to prove popular with retail investors, particularly those looking to generate passive income.

As someone who has no qualms about receiving cash for merely holding a stock, should I be adding the FTSE 100-listed bank to my own portfolio?

Big dividends

Let’s start by taking a closer look at that compelling income stream.

With a yield approaching 6.5% for the current year, Lloyds shares throw off far more cash than the majority of companies in the lead index. It’s also not far below the most recent inflation reading of 7.9%.

For further comparison, the index yields 3.7%. So I’d be getting a lot more bang for my buck in terms of income if I were prepared to buy here over a bog standard tracker fund that also charges ongoing fees.

Why so high?

Part of the reason the yield looks so good is Lloyds shares haven’t been in great form in 2023. A near-10% drop at the time of writing leaves the stock lagging behind the FTSE 100 index (-1%).

Put simply, a falling price pushes the yield up.

Now, a high yield can occasionally be a red flag. It can suggest that the market is growing concerned about a company’s earnings. Ultimately, this may impact its ability to pay those all-important dividends.

This is why I always make a point of looking ‘underneath the bonnet’ when faced with a stock offering a big income stream.

That said, this drop does leave the stock looking staggeringly cheap. As I type, it changes hands for a little less than six times forecast earnings.

So are Lloyds shares a bargain?

Based on recent news flow, there’s an argument for saying the market is being too bearish on Lloyds shares.

After all, frequent rate rises by the Bank of England have been good news for the bank’s net interest margin. This is the difference between the rates offered to savers and charged to borrowers.

Last month’s half-year numbers back this up. Back in July, Lloyds posted a big jump in profit compared to the previous year. Particularly noteworthy was the 15% increase in the interim dividend.

The latter tends not to happen if management isn’t confident in its projections.

Heavily exposed

Then again, perhaps we shouldn’t be surprised by that valuation. The UK economy is hardly firing on all cylinders. Indeed, Lloyds shares may sink lower if inflation doesn’t dip as economists predict (hope) later this year.

One concern for me is that the bank is heavily exposed to the mortgage market. Since the cost-of-living crisis is still very much with us (and the base rate is now at 5.25%), I’m inclined to think the share price could remain under the cosh.

Another potential headwind is that banks have been accused of being too slow to pass on rate hikes to savers. With the Financial Conduct Authority now getting involved, Lloyds’s aforementioned margins could be hit.

My verdict

All things considered, the murky outlook means I’m still not inclined to buy the stock today. This is the case even though I suspect the company’s cash returns are pretty secure (but never guaranteed).

Instead, I’d rather opt for other, less cyclical blue-chip stocks offering a more balanced mix of income and growth.