The Best Income Buy: Royal Bank of Scotland Group plc Or Lloyds Banking Group PLC?

In total, the banking industry has set aside £22bn in compensation for the mis-selling of PPI. The businesses withstood the aftershocks, and now are performing above and beyond any reasonable expectations from, say, five years ago at the height of the financial crisis. The worst might now be over.

What’s more — these are well known blue-chip brands trading at variously collapsed share prices. The industry is a pseudo oligopoly with high barriers to entry: long term, therefore, there’s the inherent likelihood of profitability. That is if there’s no more recklessness. Stable, steady, and best of all boring is what I’m after.

What chance do Royal Bank of Scotland (LSE: RBS) (NYSE: RBS.US) and Lloyds (LSE: LLOY) (NYSE: LYG.US) have at matching that descriptor? We’ll take a look.

Royal Bank of Scotland

rbsIf you’re investing for income — perhaps you want to build a nest egg that will leave you with regular cash — then RBS might seem like an odd case to put forward. There is no dividend, of course, and there hasn’t been since 2008.

But RBS has made a leap of progress after meeting with the treasury to retire the Dividend Access Share, a financial instrument created as part of the bank’s £45bn bailout, which gives the government priority over dividends. The Chancellor, George Osborne, commented: “This is another important step on the road to a more resilient banking system.”

RBS, however, is at least a year or more away from reporting a profit after posting pre-tax losses of £8.2bn in 2013. The bank is cutting costs and will slash around 30,000 jobs. Losses attributable to litigation and the PPI scandal should ease considerably.

Analysts at Investec believe a 10p dividend in 2015 could be forthcoming. That implies, based on today’s 300p share price, a prospective dividend yield of 3.3%. Is that optimistic? Perhaps, yes, at least on that time scale.

Lloyds looks like a better opportunity to me.

Lloyds Banking Group

LLOYWhen looking to build a divided portfolio it isn’t a requirement to dedicate your entire focus on searching for high yields. Indeed, high-quality companies with yields that outstrip the market average usually come with a premium price tag. Lloyds, on the other hand, looks affordable right now.

The shares trade on a P/E of 10 and, after doubling underlying profits in 2013, Lloyds is targeting a dividend payout ratio of 50% in the medium term.

Analysts are predicting a 2p dividend in 2014, which means if you bought today, you could secure yourself an initial 2.7% yield. Two years from now, according to guidance, the dividend could increase to 4p (5.4% yield).

That fits my criteria for an income stock with dividend growth potential. The risk is in a single word: potential.  But if it were otherwise, Lloyds would be less affordable, and considerably less intriguing.

Appetite for risk

Perhaps you have a different investing style to mine. Indeed, I hope you do, elsewise me, you and everybody else would lose out. Rather than mirroring any one person, style or strategy, it's essential to create your own unique angles. It's here you can gain an edge on the market.

I'd recommend you read the "Motley Fool's Guide To Banks". See if you can spot value that I've missed.

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Mark does not own shares in any company mentioned.