In rising markets, it often pays to look beyond the obvious choices when hunting for potential value and income stocks.
Two companies that updated the market this morning fall into this category. Car dealer Pendragon (LSE: PDG) and listed private equity firm 3i Group (LSE: III) aren’t popular choices among private investors. Both have performed well since the financial crisis but which is the strongest buy now?
Pendragon’s normalised earnings per share have risen by an average of 17% each year since 2010. 3i’s earnings per share are up an average of 34% each year since 2011. Dividends have also risen strongly at both firms.
Invest like a PE guru
Stock market investors wanting exposure to private equity have very few choices. FTSE 100-listed 3i Group is one of a handful of listed private equity firms on the London market. The group said this morning that it will sell its debt management business — which manages corporate debt funds — for £222m to Investcorp.
3i expects to book a £36m profit on the sale of this unit, which it purchased in 2011. Chief executive Simon Borrows said that while the debt management business has produced strong cash flows, “it fits less well with the 3i of today.” The business will now be focused on just two areas, private equity and infrastructure investment.
The proceeds of today’s deal will be invested in the business but 3i shares have remained broadly flat today, suggesting that the market thinks the near-term effect on profits will be neutral.
The shares have risen by 228% over the last five years as a restructuring led by Mr Borrows has delivered strong results. Earnings growth will always be lumpy due to the long-term nature of 3i’s investments. But the pace of growth does appear to be slowing. Earnings per share are expected to rise by just 6% during the current year and may fall by 24% next year, based on broker forecasts.
Although 3i’s forecast P/E of 7.3 is tempting, I think it makes more sense to value an asset-based business like this in terms of book value and yield. On these measures, 3i looks fully priced. The shares have a price/book ratio of 1.4 and offer a forecast yield of just 2.8%.
I’d continue to hold, but would probably wait for a better opportunity to buy more.
Shares in car dealership groups have sold off hard since June’s Brexit vote, despite trading remaining robust.
Today’s quarterly statement from Pendragon is a good example. Like-for-like revenue rose by 4.7% during the three months to 30 September, while underlying pre-tax profit rose by 6.3%.
New car registrations only rose by 1.4%, but Pendragon used today’s statement to remind investors that after-sales is the largest contributor to profits. Like-for-like gross profit from after-sales rose by 3.2% during the period. The number of cars under three years old has been rising. Such cars are usually under warranty and maintained at main dealers, such as those run by Pendragon.
Pendragon is the largest listed firm in the UK automotive retail sector. It also offers the highest dividend yield. If you believe the UK economic outlook will remain fairly stable, then Pendragon’s forecast P/E of 7 and 5.1% forecast yield may be worth considering.