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Are these banks better long-term buys than Lloyds Banking Group plc?

Lloyds Banking Group (LSE: LLOY) is no doubt a popular banking share in the UK. In fact, the stock is regularly the most traded stock across the whole market, let alone the banking sector. After years of poor profitability, Lloyds’ prospects are definitely looking up.  

Having said that, Lloyds isn’t the only UK bank that looks to offer investment potential right now. Many of the challenger banks are trading at very attractive valuations. Could these stocks outperform Lloyds in the long run?

Aldermore Group

With a market cap of £770m, Aldermore Group (LSE: ALD) is a much smaller outfit than Lloyds. However, smaller companies can provide excellent growth opportunities and this is a bank that is growing at an impressive rate.

Over the last two years, revenue and net profit at the challenger bank have surged from £175m and £38m, to £278 and £94m, and City analysts expect growth of 10% and 9% respectively this year. Earnings per share of 29.4p are forecast for FY2017, placing the bank on a forward looking P/E ratio of just 7.6. By contrast, Lloyds trades on a forward looking P/E ratio of 9.2.

Aldermore is expected to pay a maiden dividend this year, with analysts pencilling in a payout of 3.75p per share at present. That equates to a yield of 1.7%, which is lower than Lloyds’ yield however, the payout is forecast to grow significantly in coming years.

In its full-year results in March, Aldermore stated that Britain’s exit from the EU was unlikely to have “any material impact” and that the loan book should grow between 10%-15% this year. It went on to say that it expects to deliver a return on equity in the high teens over the medium term. An update in May stated: “Aldermore has made an excellent start to the year, with continued strong progress on our strategic priorities and financial performance ahead of our expectations.”

The next update from the bank is interim results on 10 August. This is one to watch closely in my opinion.

Virgin Money Holdings

Also offering value in the challenger bank space is Virgin Money Holdings (LSE: VM), provider of residential mortgages, savings, credit cards and currency products.

Like Aldermore, Virgin Money has recorded impressive growth in recent years with revenue and net profit surging 13% and 26% respectively last year. City analysts have forecast growth of 12% and 13% for FY2017.

The £1.35bn market cap bank released its interim results this morning and while underlying profit before tax surged 26% to £128.6m, the market wasn’t impressed with the bank’s net income margin of 1.59% and slightly lower net interest margin guidance for the full year. As I write, the shares are down 7%.

However, the challenger bank did enjoy a 7% rise in customer loan balances and a decrease in the cost-to-income ratio to 53.9% from 58.8% last year. Impressively, the interim dividend was boosted a significant 19% to 1.9p. Chief executive Jayne-Anne Gadhia stated: “We will continue to drive growth, quality and returns, put customers at the heart of everything we do, and we remain on track to sustain a solid double-digit return on tangible equity (RoTE) in 2017.”

After the 7% fall today, Virgin Money Holdings now trades on a forward looking P/E ratio of just eight. For patient long-term investors, I believe the fall could be a good opportunity to buy the shares at an attractive valuation.

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Edward Sheldon owns shares in Aldermore 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.