Should I Sell Lloyds And Buy Direct Line?

Published in Investing on 12 December 2012

A Fool weighs up the investment merits of Lloyds (LSE: LLOY) vs Direct Line (LSE: DLG).

Lloyds Banking (LSE: LLOY) (NYSE: LYG.US) is part-owned by the UK taxpayer, following a bailout received during the financial crisis. Investors would not be able to buy shares in Direct Line (LSE: DLG) if Royal Bank of Scotland (LSE: RBS) had not also received a bailout. EU regulators demanded that RBS sell its insurance operations, and 35% of the new company was offered to new investors in October.

In the last year, Lloyds has been one of the UK's best-performing UK shares, rising 91.1%. Direct Line has also done well in its short life. Since its October IPO, the shares are up a handy 17%.

One of the biggest mistakes that investors make is hanging onto shares when there is a better opportunity available elsewhere. It is something I have been guilty of. If I own shares in one company, I am often reluctant to sell unless it reaches my target price -- even if another investment has more potential.

Currently, I own Lloyds but not Direct Line. Following Lloyds' huge rise, could it be time to switch?

Lloyds and Direct Line: head to head

CompanyPrice (p)P/E (forecast)Yield (forecast, %)Market cap (£m)
Lloyds Banking46.918.8032,920
Direct Line2059.510.03,090

Lloyds profits continue to suffer from huge asset writedowns and Payment Protection Insurance compensation costs.

There is still no dividend at Lloyds, but the high price-to-earnings (P/E) ratio suggests that the market is expecting a significant recovery in earnings. After some incredibly tough years, there are hopes that the black horse is about to break into a canter.

Direct Line is expected to announce a dividend with its next results. Brokers forecast an 8p dividend for 2012, rising to 12.6p in 2013. This would make Direct Line one of the best yields around. Expectations are for Direct Line to report 21.8p of earnings per share (EPS) for 2012, followed by 20.6p in 2013. Although it is disappointing not to see growth being forecast, Direct Line has the more reliable earnings at present. That is a quality the market always values.

The winner is...

As the UK economy recovers, I expect that Lloyds will emerge from the shadows of the financial crisis. Though the shares are already up significantly, I see further considerable upside. Direct Line is a good income share, but the forecast profit decline will likely hold back the shares.

If Lloyds shares rose 50% then I'd seriously consider the switch. For now, though, I will keep my money on the black horse.

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> David owns shares in Lloyds and Royal Bank of Scotland, but none of the other companies mentioned.

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