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Is this bargain basement stock with a 5% yield too good to be true?

Photo: IG Group: Fair Use

The Financial Conduct Authority’s call for greater regulation has dented the entire spread betting industry but is the largest player, IG Group (LSE: IGG), simply too cheap to pass up now that its shares trade at just 12 times forward earnings while offering a safely covered 5.7% dividend yield?

If any company in the sector was going to escape the FCA’s tightening leash it would be IG as the company was already looking to transition from offering highly leveraged bets to more mainstream stockbroking services in all of its main markets.

However, new services such as its own ETFs have yet to make an impact on the company’s bottom line and are unlikely to do so for many years to come. And in the meantime IG is facing down the potential of significantly lower growth rates and margin compression should the FCA clampdown on highly leveraged trading by retail investors.

IG has already moved ahead of the regulators in some regards by doing away with popular binary trading options that netted around £15m in revenue last year. To make up for these lost sales the company ramped up its marketing spend by a whopping 64% year-on-year in H1 to bring in new clients.

Increased advertising is finding new clients as the company expects a 7% rise in on-year sales. But this is also cutting into what were once sky-high margins as management guided for profits that are only “marginally ahead of prior year.” And the worst may be yet to come as analysts are penciling in a 14% reduction in earnings next year as the full effects of discontinued products and increased marketing spend filter through to the bottom line.

Considering its flat or falling profits, the regulatory scrutiny surrounding the industry, and uncertainty over whether IG Group will prove as adept at stockbroking as it has at spread betting, I don’t believe the company’s shares represent any great bargain at their current valuation.

Shop ’til you drop 

Another big yielder that some may be interested in is shopping centre owner Hammerson (LSE: HMSO), whose shares trade at a pricey 19 times forward earnings but still offer a 5.2% yield.

The company has done phenomenally well in recent years as exploding land values across the UK have driven up the value of its properties and positive consumer confidence has increased rents from tenants.

Indeed, even as Brexit knocked back property value growth and dented consumer confidence for many property firms, Hammerson still recorded a 4.1% on-year rise in net asset value per share in 2016. This was largely due to international diversification and continued active management of the portfolio that is increasingly skewed towards high-end outlets and shopping centres that have so far proven resilient towards weakness in the broader economy.

However, I won’t be buying shares of Hammerson at this point due to the company’s lofty valuation compared to peers, relatively high level of leverage, and a slew of recent data suggesting consumer confidence in the UK is weakening. Although the company is well run and has an attractive portfolio, at this point in the economic cycle investing in a REIT focused on retailers seems a very dangerous proposition.

While Hammerson's valuation may be looking stretched, that's not the case with the Motley Fool's Top Small Cap of 2017, which is trading at just 8 times earnings. And this bargain basement valuation comes with a fair dose of growth as the company has boosted earnings by double-digits in each of the past four years.

To discover this under-the-radar value and growth superstar, simply follow this link for your free, no obligation copy of the report.

Ian Pierce has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.