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Why I’d avoid Lloyds Banking Group and buy this superstock instead

It’s no secret I’ve been bearish on the prospects of Lloyds Banking Group (LSE: LLOY) for some time. I thought as long ago as 2014 that the big rebound up-move for the share price looked as if it could be over. So far, it has been, and the action has been broadly sideways on the share-price chart ever since.

Downside risk

The market has been compressing the valuation even as earnings have been rising. There’s logic in that. I reckon the market is discounting progress on earnings because it expects another cyclical plunge down the road – it just doesn’t know when, so it’s pushing down the valuation while waiting.

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When the cycle turns down, I think it will cause earnings, the dividend, and the share price to all fall together. So I’m not interested in harvesting the dividend income either. After all, a decent 50%-plus plunge in the stock could wipe out years’ worth of my dividend gains. I don’t believe out-and-out cyclical shares such as Lloyds ever make good candidates for a buy-and-hold long-term investing strategy, whether that strategy aims for capital growth, dividend income, or both.

That’s why I’d avoid shares in Lloyds Banking Group and buy those of the FTSE 100’s 3I Group (LSE: III) instead. I reckon the firm is something of a superstock right now, scoring well against traditional quality, value and momentum indicators.

Growth potential and value building

3I’s private equity and infrastructure investment business isn’t immune to the effects of cyclicality. However, recent good trading is encouraging, despite the volatile economic landscape. The firm’s buy, build and sell strategy adds more value to operations than Lloyds’ business model, which could help it withstand any economic downturn that may come along. There’s also a decent pile of net cash recorded on the balance sheet, which could prove handy if economic conditions deteriorate.

Ignoring cyclicality for a moment, I think 3I has decent long-term growth prospects and an opportunity to create far more value for shareholders in the long run than Lloyds might. The forward-looking dividend yield is running close to 3.5% for the trading year to March 2020, which I see as attractive.

Indeed, the dividend has grown around 290% over the past six years and I think further increases look likely when considering a five-to-10-year-plus investing horizon. I’d be happy to accumulate 3I shares to lock in that growing dividend income while waiting for further capital growth to arrive.

If there is a downturn in the meantime, I’d hold through it with the expectation that 3i stock would recover well on the other side. That’s not a risk I’d take with Lloyds Banking Group, though. The last big downturn nearly saw off Lloyds completely and many of its banking peers too!

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Kevin Godbold has no position in any 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.