Why I’d forget the Lloyds share price and go for this future income champion instead

There are many things to like about Lloyds Banking Group(LSE: LLOY) as an investment.

The bank is one of the largest in the UK with millions of customers, so it has a tremendous competitive advantage. What’s more, unlike its other peers at the top of the market, Lloyds is relatively simple and easy to understand because there’s no investment banking arm stuffed full of complex derivatives or skeletons in the closet.

Then there’s the stock’s dividend potential. For fiscal 2018, City analysts believe the company has the financial clout to pay investors 3.4p per share in dividends, which translates into a dividend yield of 5.8%. Further growth is expected for 2019, giving an estimated yield of 6.2%.

And as the bank is subject to strict rules and regulations, enforced by not one but two regulatory bodies (the FCA and PRA), investors can rest safe in the knowledge that the bank is not distributing more to investors than it can afford.

Finally, there’s the stock’s current valuation. Shares in Lloyds are changing hands today for just 7.7 times forward earnings. In my opinion, this severely undervalues the business. Indeed, the rest of the UK banking sector is trading at an average multiple of around 10. I reckon Lloyds’ size and position in the market justifies a premium to the rest of the banking industry.

However, while I can see that there are many things to like about Lloyds as an investment, there’s one thing I’m worried about.

Economic uncertainty

Even though the bank has almost impeccable dividend credentials, when it comes to growth, the outlook is more uncertain. As my Foolish colleague Kevin Godbold recently pointed out, the group’s profits are extremely exposed to economic cycles, and while profits have been rising recently, there’s no telling when the tide will turn.

Because of this uncertainty, I would avoid Lloyds in favour of dynamic business Gresham House(LSE: GHE). With a market value of just under £100m, this asset manager is a tiddler compared to Lloyds, but it is growing fast.

For the six months to the end of June, assets under management increased by 148% and total income leapt 98%. As well as organic growth, Gresham’s management has made several acquisitions over the past year and plans to make more in the years ahead to increase the group’s exposure to new markets and boost the number of services it offers to clients. With £33.3m of cash and liquid assets, the firm has plenty of financial firepower to pursue this strategy.

And as Gresham’s growth is only just getting started, I believe the company will generate much better returns for investors going forward than Lloyds.

The one downside of the stock is that it does not offer a dividend. But management plans to change that during the next few months. In today’s half-year results release, the company declared its, “intention to accelerate dividend policy with an initial payment in 2019.“

With a third of its market cap made up of cash, Gresham can undoubtedly afford a substantial distribution, although in my view it is more likely the company will start small and increase the payout rapidly as earnings growth accelerates.

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Rupert Hargreaves owns no share 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.

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