One bargain-basement dividend stock I'd buy and one I'd sell

One bargain-basement dividend stock I’d buy and one I’d sell

These two dividend stocks could have different futures.

Peter Stephens

Having held various senior management positions in the manufacturing sector, Peter founded his own manufacturing company in 1996. This was subsequently sold in 2007. Meanwhile, his passion for investing (which began during the privatisations of the 1980s) remains strong and he couples this with writing for The Motley Fool as a Contractor. His investment style is value-oriented; focusing on company fundamentals, as well as assessing the strength and presence of a competitive advantage. While above-average growth prospects remain very attractive, a greater focus on dividends has crept in since Peter became a part-time retiree in 2007.

Published 13 October, 2017 11:20 am BST

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The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

With inflation moving higher in recent months, dividend shares are understandably becoming more popular among investors. This is to be expected, since inflation is eating away at the value of a range of assets and causing negative real returns in some cases.

However, not all dividend stocks may be worth buying at the present time. Some stocks may offer high yields, but have relatively uncertain growth outlooks. With that in mind, here is one dividend stock which appears to be worth selling, followed by another that could be a sound buy.

Falling profitability

UK consumer marketing business NAHL (LSE: NAH) released an update on Friday. The legal services-focused business announced that it has established its second Alternative Business Structure (ABS) in partnership with Lyons Davidson. The ABS will trade under the name National Law Partners and is expected to commence in November.

This forms part of the company’s strategy to advance its business model following the Personal Injury reforms announced by the government. In the long run, the ABS could help the company to grow its share of the Personal Injury market.

However, in the next couple of years the company is forecast to post a significant fall in its bottom line. For example, in the current year its earnings are due to fall by 11%, with a further decline of 20% expected next year. This means that dividends are expected to be cut from 19p per share last year to 13p per share in 2018.

While this still means that NAHL has a forward dividend yield of 8.9% and shareholder payouts should be covered 1.5 times by profit, the stock may struggle to make gains. Investor sentiment could decline in response to falling profitability, which means that its high income return may be more impressive than its total return.

Growth potential

In contrast, FTSE 100-listed Smurfit Kappa (LSE: SKG) is expected to post impressive earnings growth next year. The paper-based packaging specialist is forecast to grow its bottom line by 15% in the next financial year. When combined with a modest price-to-earnings (P/E) ratio of 12.5, this gives the stock a price-to-earnings growth (PEG) ratio of just 0.8. This suggests that its share price could move higher.

As well as growth potential, Smurfit Kappa also appears to have dividend appeal. The company has a dividend yield of 3.4% from a shareholder payout that is covered 2.4 times by profit. This suggests that dividends could grow at a much faster pace than profit without reducing the reinvestment potential available to the business.

With relatively solid profit growth over the last five years, Smurfit Kappa could prove to be a sound buy for the long term. Since the outlook for the UK economy is uncertain, it could provide a mix of defensive attributes, dividend growth potential and capital gains over the long run. As such, now could be the perfect time to buy it.