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Why I’d trade in Lloyds Banking Group plc for this 5%+ yielder

After nine gruelling years the long-promised rosy future of a privatised Lloyds Banking Group (LSE: LLOY) paying out bumper dividends to its shareholders appears to finally have arrived. As PPI payments draw to a close consensus analyst forecasts have the banking giant paying out a 3.99p dividend for the year to December that would yield around 5.9% at today’s share price.

But despite this hefty yield, I’d skip investing in Lloyds and instead consider insurer Esure (LSE: ESUR), whose stock offers a 5.21% trailing yield and has far higher growth potential in my eyes.

My reticence to invest in Lloyds is multi-faceted, but given the many years I have until retirement, it’s Lloyds low growth potential that has me most concerned. Now, low growth isn’t necessarily a bad thing. If the financial crisis taught us one thing, it’s that banks striving to hit ever-higher growth targets due to intense shareholder pressure can end very, very badly.

But I’m looking to grow my portfolio through capital appreciation and unfortunately Lloyds doesn’t offer much of this in my opinion. The reasons for this are twofold: the overall domestic economy is growing sluggishly, and Lloyds already has such high market share that it will find it difficult to significantly move the dial organically.

The bank’s management is aware of this, and its recent £1.9bn purchase of Bank of America’s MBNA credit card arm will enhance its offerings in this hot sector. However, this deal will only grow annual turnover by £650m initially, which is a drop in the ocean for a bank that controls nearly a quarter of the domestic mortgage market and is the largest provider of retail banking services.

On top of this, the bank’s current valuation of 0.99 times book value means that unlike peers such as Barclays or Royal Bank of Scotland, it doesn’t trade at a steep discount that signifies potential capital appreciation as turnarounds are effected.

Motoring up for future growth

These are the reasons I’m looking at Esure, which is growing rapidly from a small base as it takes market share in the motor insurance segment. This morning’s release of the company’s results for the nine months to September showed its gross written premiums rising 25.8% year-on-year to £625.8m and the number of in-force policies rising 10.4% to 2.3m.

And its management team isn’t chasing growth at all costs as gross written premiums for its smaller home insurance business fell 6% to £64.3m as highly competitive industry pricing led to fewer opportunities to write profitable premiums. In the trading update, CEO Stuart Vann also said the group now expects to beat previous guidance and for its combined operating ratio, an insurance metric of profitability which is better when lower, should come in at the lower end of its 96%-98% range.

Now, analysts do expect a slightly lower dividend payout this year as management has directed capital towards profitable growth rather than shareholder returns as motor insurance costs have skyrocketed. Yet consensus forecasts still predict a 12.21p per share payout that would yield 4.6% at today’s share price and remain comfortably covered by earnings. With a sane valuation of 14.4 times forward earnings, a substantial dividend yield and very good growth prospects, Esur is definitely higher up on my watch list than Lloyds.

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Ian Pierce has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays and 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.