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Why I’d shun Lloyds Banking Group plc and buy this dividend growth champion instead

I sold my investment in Lloyds Banking Group (LSE: LLOY) at the end of 2013. At the time, it seemed to me that the firm’s operations and the share price were struggling to advance further after the post credit-crunch lows of early 2009.

From bull to bear

Then it occurred to me that US investing legend Peter Lynch’s warnings about cyclical firms could play out with Lloyds and I changed from bull to bear in January 2014. I’ve been bearish on the firm as an investment ever since. Such bearishness on LLoyds, and the other big London-listed banks, has proven to be broadly ‘correct’ since the beginning of 2014 because the share prices of the banks have remained stagnant, struggling to advance.

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Yet earnings have risen in many cases, as with Lloyds, and dividends have reappeared. But even Lloyds’ fat dividend yield now doesn’t attract me back to the stock. My belief is that bank dividends are inherently risky and in danger of being cut down the line. Peter Lynch wrote in his books that valuations of cyclical firms tend to compress as macroeconomic cycles roll out, which could drag on share-price progress. The reason for that is that the market is trying to account for the next cyclical down leg, which will surely arrive – at some point.

So, Lloyds looks to me like it has limited upside potential and big downside risk, which is the wrong way around for my liking. That’s why I’d shun Lloyds and look closely at a dividend growth champion such as UK-focused construction and regeneration firm Morgan Sindall Group (LSE: MGNS) instead. The company carries out projects through its six divisions of Construction & Infrastructure, Fit Out, Property Services, Partnership Housing, Urban Regeneration and Housing. Such a mix of activities means the firm is “geared toward the increasing demand for affordable housing, urban regeneration and infrastructure investment.”

An impressive dividend record

The share price is perky today, up around 4% as I write on the release of the half-year report. Good trading figures include revenue 9% higher than a year ago and adjusted earnings per share up by 28%. The directors seem confident in the outlook and pushed the interim dividend 19% higher, which continues what has become an impressive record on dividend-raising from the firm. Since 2012, the annual dividend payment has risen by around 70%. But City analysts following the firm expect more and predict that the total yearly dividend will increase by more than 10% this year and around 7% next year. Meanwhile, today’s share price close to 1,488p puts the firm on a forward dividend yield for 2019 of around 3.6%.

Chief executive John Morgan said in the report the Fit Out and Construction & Infrastructure divisions have both “continued to deliver margin and profit growth” along with a good performance from the Urban Regeneration division. He talked of a “significant number” of opportunities in regeneration and reckoned the firm’s strong balance sheet and cash position leave it “well-placed to invest further in this key strategic area.” The second-half outlook for the Fit Out division is “very positive” and Mr Morgan expects Morgan Sindall to achieve a full-year financial outcome “slightly ahead of previous expectations.” I think the stock is well worth your research time right now.

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Kevin Godbold 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.