Key points

• Lloyds is expected to deliver inflation-beating dividend growth
• Rising interest rates could help to lift profits
• The bank’s 300-year history gives me confidence in its future

I’ve often heard investors talk about Lloyds Banking Group (LSE: LLOY) as a potential value trap. But I’m starting to think this view is unfair. Lloyds’ share price has doubled since the market crash in April 2020. I think it could still have further to go.

The bank’s performance is improving and I expect shareholder returns to increase too. I think it might still be cheap.

As an income investor, Lloyds is a share that often appears on my radar. The bank’s 300-year history tells me that it’s likely to be here long after I’m gone. And the stock’s 4.8% forecast dividend yield provides me with an opportunity to generate a market-beating income today.

I don’t have too many doubts about Lloyds’ long-term survival. But I’ve avoided buying the shares in the past because of the bank’s inconsistent growth and weak profitability since the 2008 financial crisis.

Much of this is linked to the record low interest rates we’ve lived with over the last decade. In a competitive mortgage market like the UK, low interest rates force lenders to cut their profit margins to win new customers.

For Lloyds, this has meant the bank’s return on equity has averaged just 5% since 2016. That’s not enough to tempt me, as such low returns often limit share price and dividend growth.

A turning point?

So far, I’ve been right to avoid Lloyds. Although its share price has risen by 40% over the last year, the stock is still worth 20% less than it was five years ago. The bank’s dividend has suffered too. Although profits have returned to pre-pandemic levels, Lloyds’ 2022 dividend is expected to be nearly 25% lower than in 2019.

However, I think that the prospect of rising interest rates could change the picture for the firm. The bank’s balance sheet looks very strong to me. If it was able to improve the profitability of its mortgage lending, I think profits and dividends could soar over the medium term.

My concern is that the Bank of England’s interest rate rises will be small and slow, to limit the risk of triggering a recession. That might not be enough to give Lloyds the profit boost I’m hoping for.

Lloyds share price: what next?

The good news is that even without further rate rises, Lloyds’ dividend is expected to grow much faster than inflation. Broker forecasts suggest the payout will rise by around 12% in both 2022 and 2023. With a starting yield of around 4.3%, that looks attractive to me.

Although profit growth may be more sluggish — especially if interest rates remain low — analysts expect the bank to be able to use some of its surplus capital to support more generous dividends.

On balance, I think Lloyds shares still look reasonably valued. I think the bank’s share price could continue to rise through 2022 and beyond. If I was building a FTSE 100 dividend portfolio today, I would definitely consider adding Lloyds to the mix.

Roland Head has no position in any of the shares mentioned. 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.

Some passive income ideas can seem too good to be true.

Take investing in dividend shares, for example. Many provide a substantial stream of unearned income. But some of them can involve heightened risk, which might mean that the income falls or dries up in future.

Double-digit yield

This has been on my mind lately when I have been thinking about Diversified Energy (LSE: DEC). The company currently offers a dividend yield of 10.2%. So, if I put £10,000 into Diversified shares today, I would expect annual passive income of around £1,020. Not only that, but Diversified pays quarterly and has increased its annual dividend in recent years.

That all sounds very attractive to me from a passive income perspective. But how can the little-known energy company support a double-digit yield?

New business model

Diversified is in the natural gas and oil business. But whereas other energy companies get in early in the lifestage of a gas well, Diversified gets in late. It specialises in buying up old wells other operators may see as no longer worth owning.

This is an unconventional business model in oil and gas. It could be a stroke of genius. It takes away the vast exploration and development costs associated with energy majors like BP and Shell. But it raises the question of how costly wells are to maintain as they enter their twilight years. Ultimately, wells need to be plugged and that costs money. With around 67,000 wells on its books, the liabilities could be substantial for Diversified. If capping costs eat into profits, that could hamper its ability to pay out those juicy dividends.

Positive outlook

Diversified is well aware of the capping issue. Indeed, it announced this week that it has acquired a company that specialises in capping wells.

There was other good news in this week’s announcement. The company has expanded its footprint, acquiring new wells that let it grow in the US outside its heartland in the Appalachian mountains. Production last year was up 19%. The unconventional business model seems to have been lucrative so far, and is growing at speed.

Is this passive income idea for me?

How lucrative the model remains in future depends partly on energy prices, which are outside the company’s control. In the short term it manages this risk through hedging its output, or agreeing sales in advance at a set price. But in the long term, any sustained downturn in energy prices could hurt profits at the firm and its ability to fund the dividend.

I also think the capping costs for its estate are a significant risk. If they turn out to be substantial, that could hurt the company’s dividend. That means that the dividend is not guaranteed to last. But that is true of any dividend. For now, at least, the dividend is not too good to be true. It reflects the success seen so far at Diversified. That may continue.

But I think the high yield reflects the risks of the novel business model pioneered by Diversified. In time, that could mean the dividend is not sustainable. So, although the dividend is not too good to be true today, that does not mean that it will continue. I am not buying Diversified for my portfolio at the moment.

Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

America’s tech-heavy NASDAQ index has soared effortlessly upwards in recent years. Standing at a shade under 6,000 in early 2017, it had reached 16,057 by mid-November last year.
 
And then, a correction set in.
 
December saw some gyrations and wobbles, and the fall resumed in earnest in early January. By 27 January, the NASDAQ stood at 13,353, although it has fractionally recovered to just over 14,000 as I write these words.

Looking at a long-term chart, in terms of the steepness of the decline you have to think of the sort of share price collapses seen as the world went into Covid-19 lockdown in order to see anything comparable.
 
And inevitably, as interest rates start to rise, fund managers and investment houses are likely to rotate out of growth stocks and move into the fixed income markets — bonds, and treasuries. So it’s rational to expect tech stocks to remain under pressure.

Too big to ignore

Now, I struggle to get excited about some tech companies. Peloton? Zoom? Sure, they have good stories, but do those stories support such lofty valuations?
 
But here’s the thing: take a look at the NASDAQ 100, and you’ll see many of America’s very largest companies.
 
The seven largest companies in the S&P 500, for instance, are all tech stalwarts from the NASDAQ 100: Microsoft, Apple, Amazon, Tesla, Alphabet (as Google’s holding company is known), Meta (as Facebook’s holding company is known), and graphics chip manufacturer Nvidia. Further down, you’ll find the likes of Oracle, Adobe, eBay, Broadcom, Electronic Arts, Qualcomm, Netflix, Cisco, Intel, and PayPal — again, all from the NASDAQ 100.

And the pain hasn’t been universally shared. In late January, Netflix’s shares fell over 20% in a day, following a disappointing earnings report. Meta attracted headlines around the world with a 26% fall in a day, which wiped US$230 billion from its market capitalisation — a record daily loss. Yet Microsoft — America’s largest company — escaped fairly lightly, falling just 9%, far less than the overall NASDAQ index.

Tricky to value

Now, it’s easy to be dismissive of tech stocks’ stratospheric valuations.
 
Take Tesla, which — ranked fourth in the S&P 500 — is America’s fourth-largest company by market capitalisation. That makes it worth more than Ford and General Motors, and also Daimler, Volkswagen, Toyota, Honda or any other automaker.
 
Is that valuation really justified for a business that has made just over two million vehicles in its entire life? I have absolutely no idea.
 
But I do know that similar sentiments could have been expressed for pretty much all the tech stocks mentioned above, at similar points in their lives. Microsoft, Apple, Amazon, Google (as it was then), Facebook (ditto) and so on and so on: lofty valuations go with the territory.

Wiring the world

Yet there’s another way to look at all this.

Which is this: tech is the way that things are done these days. Our working lives are dominated by tech, our jobs carried out through smartphones, computers, and software from the likes of Microsoft, Oracle, and Adobe.

When we’re at home, it’s the same: we chill with Netflix or Amazon, listen to music streamed from Amazon on devices made by Apple devices, and shop at eBay and — once again — Amazon. Meanwhile, our kids — or grandkids — are playing games from Electronic Arts.
 
And quite frankly, I don’t see any of that changing over the foreseeable future.
 
Meaning that while tech stocks have taken a battering — with arguably more heavy weather ahead, in the short term — today’s share prices may retrospectively turn out to be something of a bargain, for those brave enough to buy the dip.

Opportunity knocks?

Now, let’s be clear. I won’t be buying any tech stocks myself. I already have a fairly sizable holding via the Scottish Mortgage investment trust, plus several investment trusts with portfolios built around the S&P 500.
 
And at my age, I’m far more interested in income-focused dividend-paying stocks.

But if I were younger — even 10 years younger — I think I’d be taking a serious look at this market. Most of the big brokerages make it relatively straightforward to buy American stocks these days, although you should expect to have to fill in a United States government W-8BEN form at some point.

Malcolm holds shares in Scottish Mortgage. The Motley Fool UK has recommended Amazon, Apple, Microsoft, PayPal Holdings, Peloton Interactive, Qualcomm, Tesla, and Zoom Video Communications.

Hydrogen energy specialist ITM Power (LSE: ITM) is one of a number of so-called green energy shares that have attracted a lot of attention among UK investors in recent years. But after losing 57% in the past year, will the ITM Power share price keep disappointing investors? Or could the current price offer a buying opportunity for my portfolio?

Thematic investing and green energy

The enthusiasm for green energy shares is an example of what is known as thematic investing. That is when investors land on a big theme that they think will do well in future, for example because of shifts in human behaviour or the economy. Then they look at individual companies within that area that might benefit from it.

Green energy is a big theme at the moment and I expect that to become even more the case over time. A rising global population, increasing demand for energy, and concern about the environmental impact of fossil fuels means that both governments and investors see significant opportunities when it comes to green energy.

Green energy investment concerns

I am wary, though. I think environmental damage could be tackled by reducing energy consumption as well as moving to new forms of energy generation. If that happens, it could hurt demand and the future economics of energy, including green energy. My bigger concern from an investment perspective is that different people have wildly different views on what constitutes “green energy”. For example, its low carbon footprint means many people regard nuclear power as green energy. Due to environmental catastrophes such as Fukushima, I do not see nuclear power as green at all.

Over time, if some technologies come to be seen as more or less green, that could change their popularity with investors. Right now, hydrogen energy shares like ITM benefit from plugging into investor perceptions about greenness. But if alternative technologies appear to be environmentally friendlier, that could change the amount of money chasing hydrogen energy shares – and drive their prices down. On the other hand, if hydrogen gets a bigger role in meeting world energy needs, it could be positive news for shares of pioneers like ITM Power.

Why has the ITM Power share price collapsed?

Although ITM came to prominence a couple of years ago when interest in its technology soared, it has actually been listed on the London market for 18 years already. The sharp increase in share price seen in 2020 was not the first time shareholders have experienced such a sudden price surge.

Back in 2006, for example, the ITM Power share price reached £3.36 at one point. That is actually higher than the price today.

After the 2006 surge, the ITM Power share price fell back. The company spent over a decade trading as a penny share. It was not until 2020 that it reached its old price level again. So, if I had bought ITM Power shares amid investor enthusiasm at their peak in 2006, I would have had to wait 14 years just to be able to sell them without making a loss.

After a long wait, the shares not only scaled their old heights but actually reached new ones. That was last January. Since then, though, they have lost 60% of their value. Partly that reflects a consequence of their previous success. Management took advantage of an attractive share price to raise more capital by issuing new shares. That has the effect of diluting existing shareholders. I think this move can make sense to improve a company’s liquidity. But it means a shareholder ends up with less of the company than before – and there is a risk ITM will have more rights issues in future if it wants to boost liquidity. That could damage the share price. Currently there are around 613m ITM Power shares in issue. Five years ago, that number was 222m. That is considerable dilution.

But I think the main reason the ITM Power share price has tumbled is valuation concerns. Even now after a big fall, the company commands a market capitalisation of £1.6bn. That is a very large number compared to revenues.

ITM Power valuation

In its interim results last month, the company reported revenue of £4.1m and a loss for the six months in question of £15.4m. In itself, I do not find that surprising. The company is continuing to scale up and commercialise its operations. That often involves a company making losses before hopefully it turns into the black. Revenue showed a big increase, as it had been only £178,000 in the equivalent prior period. The company had more than four times as much contracted work in hand last month, in terms of power output, as it did a year beforehand. Indeed, it is so bullish it expects to start building a second factory this year. These are positive signs for the business, in my view.

But while the travel of direction looks encouraging for revenue at least, it remains miniscule compared to the company’s market capitalisation. On top of that, the long-term profitability for ITM Power is hard to gauge. For now it remains loss-making. If that continues to be the case in coming years, it may need to dilute shareholders further to raise more funds.

Am I investing?

It may be possible to justify the current ITM Power valuation. If sales grow strongly and the company becomes profitable, it could make sense. In fact, sustained positive commercial momentum could end up justifying a higher ITM Power share price than the one today. So, with the right future news stream, I do think that the ITM Power share price could recover fully to its former level.

The problem is that such news might never happen. The company has already been in existence for a couple of decades, so it is not exactly new. Given the emergence of green energy as an investment theme, I expect more competition for ITM’s technology in coming years. That could threaten the company’s long-term profitability. I see the ITM Power share price as valued for a high level of future success, but it is far from clear that such a scale of success will ever arrive. For that reason, I continue to avoid buying ITM Power shares for my portfolio.

Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

Was this article helpful?

YesNo

Was this article helpful?

YesNo

Some UK shares on an upward trajectory can go under the radar. I believe this is the case with Gamma Communications (LSE:GAMA). Here’s why I’m considering adding the shares to my holdings. 

Communications provider

Gamma is a provider of unified communications solutions as a service (UCaaS). It has operations in the UK, Germany, Netherlands, and Spain, and continues to grow into new territories. Gamma develops its solutions and owns a significant amount of intellectual property. It sells these directly to customers and via a channel partner model.

As I write, Gamma shares are trading for 1,554p. At this time last year, the shares were trading for 5% higher, at 1,640p. The FTSE AIM incumbent listed in 2014 for 205p. At current levels, this equates to a 650% return.

UK shares have risks

The UCaaS market is growing and there are many firms vying for business and market dominance. Some of these names are perhaps more established and better known in the market. Losing out to competition and not gaining market share could deal a blow to Gamma’s growth aspirations and performance. This could also hinder any returns I hope to make.

The Gamma share price has pulled back in recent months. The shares were trading for over 2,300p in September. I think this is due to two reasons. Firstly, a stock market correction has lowered the price of many burgeoning UK shares. In addition to this, macroeconomic factors have also put pressures on worldwide stocks. I’m not worried about this, however. In fact, the current Gamma share price represents an opportunity, in my eyes.

Why I like Gamma Communications shares

Gamma operates in a growth market that is experiencing tailwinds, in my opinion. The continued digital transformation throughout the world has meant more businesses require UCaaS to continue to move with the times. In addition to this, in a lot of Gamma’s core markets, such as the UK and Germany, UCaaS adoption is lagging. I believe these opportunities will boost Gamma’s performance and shares upwards.

At current levels, Gamma shares present an opportunity to buy cheap shares. The shares sport a price-to-earnings ratio of just 21. In addition to this, it pays a dividend too which could make me a passive income. I do understand dividends are not guaranteed and can be cancelled, however. Its yield stands at just under 1%.

Most of the UK shares I review have a good track record of performance. I do understand past performance is not a guarantee of the future, however. Looking back, I can see Gamma has seen revenue and operating profit grow year on year for the past four years. Coming up to date, Gamma released a post-close update in January, for the year ended 31 December. Gamma said, despite economic uncertainty, it achieved upgraded forecasts and net cash was up too compared to last year. Full-year results in detail are due in the coming months.

Overall I do think Gamma Communications is an under the radar growth stock. I’d happily add the shares to my holdings. It has a good track record, operates in a growth market, and pays a dividend. What I also like about it is that it regularly acquires businesses to enhance its own offering and boost growth.

Jabran Khan has no position in any shares mentioned. The Motley Fool UK has recommended Gamma Communications. 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.

One FTSE AIM stock I’d add to my holdings right now is dotDigital (LSE:DOTD). Here’s why.

Digital marketing

dotDigital provides cloud-based marketing solutions that allow businesses to automate their advertising and marketing campaigns. This is by sending tailored content across a multitude of channels such as social media, email, and text messages. The changing face of retail and rise of e-commerce has meant there is lots of demand for such services. 

As I write, the dotDigital share price is trading for 140p. At this time last year, the shares were trading for 190, which is a 26% drop over a 12-month period. The shares have lost 50% since September 1, when the shares were trading for 291p. 

FTSE stocks have risks

Macroeconomic uncertainty and a stock market correction have led to a sell-off in tech stocks and stocks in growth markets. Although I believe this is a temporary issue, no one can predict how long this issue could last and how far certain shares could drop. A significant share price drop for dotDigital in recent months could continue in the short to medium term, in my opinion.

The tech sector is extremely competitive and many firms are vying for market share and overall market dominance. With the rise in e-commerce and the need for digital marketing, dotDigital could see its performance, growth, and returns affected by competitors in its space. Furthermore, shares are currently trading with a price-to-earnings ratio of 38, which could still be considered expensive. There is also the chance that growth is already priced into the higher share price.

Why I like DOTD shares

My investing mantra has always been to invest for the long term. Despite the current bearish attitude in the market when it comes to growth stocks, I am always on the lookout for the best FTSE growth stocks in burgeoning markets. I believe dotDigital could grow in the coming years from the rising demand for digital marketing services. It currently possesses some lucrative strategic partnerships with leading tech names such Shopify, Adobe, and Microsoft Dynamics. I believe these partnerships will help attract new business and boost growth in the longer term.

dotDigital also has a good track record of performance. I do understand that past performance is not a guarantee of the future, however. Looking back, I can see revenue and gross profit have increased year on year for the past four years. Coming up to date, the company released an interim report at the end of January for the six months ended 31 December 2021. Recurring revenue increased by 22% compared to the same period last year and overall revenue increased by 10%. Cash generation increased and full-year guidance is currently expected to be met.

FTSE stocks that make me a passive income through dividend payments are firmly on my radar, especially those in a growth market, like dotDigital. I do understand dividend payments can be cancelled, however. At current levels, DOTD’s yield is just under 1%.

Overall, I like dotDigital shares and I’d happily add them to my holdings at current levels. The stock market correction has made them cheaper, presenting an opportunity for me. I’d expect the shares to eventually head back on an upwards trajectory as economic uncertainty fades, although this could take some time.

Jabran Khan has no position in any shares mentioned. The Motley Fool UK has recommended dotDigital 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.

Key points

• There are two possible deals concerning the BT Sport brand
• Altice owner Patrick Drahi has increased his stake from 12.1% to 18%, sparking takeover rumours 
• Cash flow increased 6% in recent results

A telecommunications giant, BT Group (LSE:BT.A) is an instantly recognisable British firm. Boasting brands like BT Sport and EE, the company is a FTSE 100 stalwart. With the potential sale of BT Sport, takeover rumours and some interesting financial results, I think the BT share price could be about to soar. Should I now be adding this business to my own portfolio? Let’s take a closer look.

Sales, takeover rumours, and the BT share price

Just this month, the firm announced it was in the final stages of selling its Premier League rights to US streaming service DAZN. This deal, thought to be worth $800m, would be a welcome cash injection for BT, which has a not insignificant debt pile of around £18.2bn. 

This transaction is complicated, however, as it has reportedly stalled. This is primarily because of the possibility of a joint sports venture with Discovery Communications. This would be an equal venture, with BT adding Eurosport UK to its portfolio of channels. While this may complicate the DAZN deal, it may also be lucrative and its conclusion may cause the BT share price to soar.

Rumours have also been swirling since December 2021 about a possible takeover of BT. The talk increased after Patrick Drahi, the owner of European telecommunications giant Altice, increased his stake in BT from 12.1% to 18%.

This purchase attracted a lot of attention. Many are wondering if Drahi is steadily increasing his stake to avoid the costs associated with a bid offer. In any case, we will not uncover his true intentions until the summer, due to UK takeover regulations. While a successful takeover would likely see the BT share price take off, we will need to wait a little longer to find out.

Mixed financial results

In the recent financial report for the nine months to 31 December 2021, BT reported a mixed bag of results. During this period, profit fell by around 3% and revenue dropped by 2%. The firm stated that this was down to “Covid-19 and supply chain problems”. For me, these appear to be short-term issues that will subside with time.

On the flip side, cash flow increased markedly by 6%, from £830m to £878m. This means that the company has the luxury of cash with which to expand or strengthen its balance sheet. This should have a very positive impact on the BT share price.

The exciting prospect of either a sale of the BT Sport brand or a joint venture might indeed the send the BT share price flying. With more information expected soon, I will be buying shares now. While the takeover rumours are interesting, and would positively impact the share price, I am more focused on the cash flow improvements that place the firm in a stronger financial position.

Andrew Woods has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.