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Are these FTSE 250 dividend stocks about to go into reverse?

License: CC0 Public Domain.

Underlying pre-tax profit rose by 29.8% to £121.6m at interdealer broker TP ICAP (LSE: TCAP) in 2016. The group — formerly known as Tullett Prebon — enjoyed the benefit of strong trading in volatile markets, which helped to push the underlying operating margin up from 13.6% to 14.8%.

TP’s acquisition of rival ICAP’s voice broking business completed on 30 December. It’s created the world’s largest voice brokerage business. But this hasn’t been without cost. TP ICAP booked a total of £56.6m in costs relating to the ICAP deal last year, pushing the group’s reported operating profit down to £73.3m.

Although underlying profit is expected to rise from £103m to £216m in 2017, dilution from the issue of new shares to ICAP shareholders means that earnings per share are expected to remain fairly flat.

In fact, broker forecasts currently suggest that TP ICAP’s underlying earnings could fall to 36.7p in 2017, from 42.5p per share in 2016. This puts the stock on a forecast P/E of 13, with a prospective dividend yield of 3.5%.

For income investors who bought at a lower price, the shares are probably worth holding. The problem — as always — is that earnings and activity levels are heavily dependent on market conditions. The group could easily outperform expectations in 2017, but it might equally underperform. This speculative element means that this is a stock I’d only want to buy when it’s obviously cheap. I’m not sure that’s true at the moment.

21% profit growth

Another firm that benefitted from strong market conditions last year is merchant banking business Close Brothers Group (LSE: CBG).

The group’s operating profit rose by 21% to £131.4m during the six months to 31 January. Earnings per share were 9% higher, at 65.1p, which should mean the group is on track to meet full-year forecasts of 125.2p per share.

Close Brothers reported a net interest margin of 8.2% for the first half of the year and a return on equity of 18%. Both figures are broadly flat compared to the same period last year, but are significantly above what’s available from banks such as Lloyds Banking Group, which reported a net interest margin of 2.7% and an underlying return on equity of 13.2% for 2016.

However, like TP ICAP, Close Brothers’ profitability depends quite heavily on market conditions. Preben Prebensen, Close Brothers’ chief executive, admitted this in his results commentary, saying that “trading conditions have clearly been favourable”.

Another way of looking at the situation is that Close Brothers’ increased profits came from an asset base that was almost unchanged. The group’s loan book rose by just 1.7% to £6.5bn during the first half, while total client assets were 3.2% higher, at £10.2bn.

These growth rates are a long way below the 9% rise in earnings per share and suggest to me that investment gains and fee income were responsible for much of the reported profit growth.

The latest consensus forecasts indicate that analysts expect Close Brother’s earnings growth to slow, with an increase of just 2% pencilled-in for next year.

However, with the stock trading on a P/E of 12 and offering a prospective yield of 4%, I think the risk of a slowdown is balanced by the potential for further gains. I’d hold.

A FTSE 250 stock with 200% upside?

I'm not sure that TP ICAP or Close Brothers are likely to double again soon. But our investment experts have identified a FTSE 250 stock which they believe could rise by 200%.

The company concerned operates outside the volatile financial sector and has a strong track record of growth. We believe these shares are significantly undervalued at current levels.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.