The one dividend stock I’d sell to buy Lloyds Banking Group plc

National Grid electricity pylons

Lloyds (LSE: LLOY) has quickly worked its way into the ranks of the FTSE 100’s top dividend stocks over the past few years. As the bank’s recovery has reached its conclusion, Lloyds has returned to its income routes, vowing to pay the majority of the income generated from operations back to investors as long as its capital buffer remains adequate.

Based on management projections, City analysts believe the bank will return a total of 3.95p to shareholders this year and then 4.5p to shareholders during 2018. At the current share price, these cash return figures are equal to a dividend yield of 5.7% for 2017 and 6.5% for 2018. Dividend payouts are covered approximately twice by projected earnings per share.

A better buy

Lloyds’ near-term dividend schedule, coupled with its dividend growth potential, leads me to believe that the bank is one of the best dividend stocks in the FTSE 100 today and stands head and shoulders above leading income stock National Grid (LSE: NG).

National Grid is one of the FTSE 100’s most defensive companies, and it’s unlikely that the company will be thrown off its pedestal any time soon.

As the primary operator of the UK’s electricity infrastructure, it’s highly unlikely National Grid will ever be replaced or face serious competition in its markets. Therefore, profits and dividends are virtually guaranteed. However, the one downside of National Grid’s defensive nature is that the business is highly regulated and profits growth is sluggish.

Over the past five years, earnings per share have hardly budged. And while analysts are expecting earnings per share growth of 13% for the year to 31 March 2018, even if the company hits this target, it will have only achieved total earnings growth of 11% in six years. Nonetheless, even though earnings growth has been non-existent, management has increased the company’s dividend payout by around 10% over the same period. As a result dividend cover has fallen from 1.4 times to 1.3 times and scope for further growth is limited.

Shares in National Grid currently support a dividend yield of 4.4% and trade at a P/E multiple of 16.4. The company looks expensive on both of these metrics compared to Lloyds, which currently trades at a forward P/E of 9.3. Further, as noted above there is more scope for dividend growth with Lloyds, and depending on economic growth, there may be more scope for earnings growth at the bank.

Foolish summary

So overall, even though National Grid has been a FTSE 100 dividend champion for many decades, it now looks as if Lloyds might be a better bet than the highly regulated electricity business. Lloyds has more room for earnings growth, currently trades a lower valuation, and supports higher dividend yield than National Grid. What’s more, the well-capitalised bank’s conservative dividend policy means that there is plenty of headroom for further dividend growth in the years ahead, a luxury National Grid no longer has.

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More reading

Rupert Hargreaves has no position in any 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.

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