Are these 5% yields still safe after today’s news?

These two mid-cap stocks boast generous yields and are UK-focused businesses. Is now the time to invest?

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Investors looking for inflation-beating dividend growth should focus on mid-cap stocks rather than the FTSE 100. At least that’s the conclusion you might draw from the latest Capita Dividend Monitor report.

This useful quarterly report shows that mid-cap dividends rose by 4.9% during the third quarter, while FTSE 100 dividends only rose by 0.9%. With UK inflation now at 1%, that’s not enough to keep up.

Mid cap London estate agent Foxtons Group (LSE: FOXT) and infrastructure and transport firm Stobart Group (LSE: STOB) both offer forecast yields of more than 5%. How safe is each company’s dividend?

Property slowdown

Recent reports from housebuilders suggest that the UK housing market is still doing well. But London is always a special case. Foxton’s comments today make it clear that the market is slowing in the capital.

Revenue fell by 14% to £37.5m during the third quarter, thanks to a 34% drop in revenue from property sales. Lettings fared better, with revenue broadly flat at £22.8m. Foxtons says that cost-cutting is helping to improve profit margins and still expects full-year results to be “broadly in line” with expectations.

The latest forecasts are for earnings per share of 6.44p and a dividend payout of 5.1p per share. This gives the shares a forecast P/E of 14.9 and a prospective yield of 5.4%. This is an attractive yield, but it’s worth noting that it’s only covered 1.3 times by forecast earnings.

Foxtons can afford to operate with a low level of dividend cover because it has no debt and remains cash generative. I don’t expect this year’s dividend to be cut. However, the outlook for dividend growth may depend on a recovery in earnings next year and I’m not sure how likely this is based on today’s trading update.

A high-flying payout?

Infrastructure and transport group Stobart will spend £12.5m to increase its stake in the group’s aviation business.  The money will go to Stobart’s 2012 investment partner Invesco, which will exit the joint venture. The deal seems reasonably priced, although it will leave Stobart with greater exposure to any future downturn in the aviation sector.

Group profits are expected to double this year, rising from £8.8m to £17.6m. That equates to forecast earnings of 5.65p per share, which puts the stock on a heady forecast P/E of 28. However, I believe Stobart’s valuation is driven more by the value of its property portfolio and its income potential than by earnings.

The group had net assets of £413.7m at the end of February, giving the stock a price/book ratio of 1.3. With growing earnings from its biomass and aviation businesses, this seems reasonable.

A second attraction is that Stobart is expected to pay out 9p per share in dividends this year, giving a forecast yield of 5.6%. Although this payout isn’t expected to be covered by earnings, the group received £37m from the sale of an investment property earlier this year. Only £11.6m of this was booked as profit, but the influx of cash means the group is well positioned to return some money to shareholders.

We should learn more next week when Stobart publishes its interim results. In the meantime, I believe the shares could be worth a closer look for income investors.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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.

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