Why I’d sell this 5% yielder to buy this FTSE 250 income stock

Here’s a brilliant FTSE 250 (INDEXFTSE: MCX) stock that could make you a fortune.

| More on:

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.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

While Pendragon (LSE: PDG) may be packing the sort of yields to embarrass much of the broader London market, I for one wouldn’t touch the business with a bargepole right now.

With new car sales falling off a cliff I think that investing in the vehicle retailer is extremely risky business, and conditions do not look likely to improve any time soon as the economic and political malaise engulfing the UK continues. What’s more, ongoing uncertainty over the future of the diesel engine is likely to keep the market under pressure as well.

Latest data from the Society of Motor Manufacturers and Traders showed registrations for new vehicles in Britain plummet 15.7% year-on-year in March, to 474,069 units. This also marked the 12th monthly drop on the spin and takes the total decline in new car sales for the first quarter to 12.4%.

The difficulties in the new automobile market have encouraged Pendragon to harden its resolve in the used car segment, and the company has targeted a doubling of annual revenues from pre-owned vehicles by 2021.

Still, the used car market will surely not prove immune to the broader pressure on consumers’ spending power either — these vehicles still remain ‘big ticket’ items for most people, after all.

Car crash

Current City forecasts do not reflect this severe toughening in market conditions, in my opinion, with analysts tipping the company to bounce from the rare 15% profits slide last year with a 7% advance in 2018.

I believe this estimate could be chopped down in the months ahead given the pace at which car sales data is deteriorating. And next year’s predicted 10% earnings improvement could come under serious scrutiny too. And as a consequence I would ignore Pendragon’s ultra-low forward P/E ratio of 8.3 times and stay away.

I also wouldn’t be surprised to see monster dividend projections also fall short of current estimates. Forecasters are expecting the full year payout to remain stable at 1.55p per share through to the close of 2019, resulting in a gigantic 5.3% yield.

But with Pendragon battling an uncertain earnings outlook and a ballooning net debt pile, which jumped to £32.4m last year from £12.1m previously, I reckon investors should be braced for disappointment.

Box it up

I believe those hunting for bright dividend stocks would be much better selling out of Pendragon today and splashing the cash on Safestore Holdings (LSE: SAFE).

The FTSE 250 self-storage giant has seen dividends balloon by triple-digit percentages over the past five years. And although another painful earnings drop is forecast for the year to October 2018 — by 29%, and the third on the spin if realised — thanks to its strong cash flows, City analysts expect shareholder rewards to keep rising. Free cash flow leapt 19% last year to £50.3m.

Last year’s dividend of 14p per share is predicted to rise to 15.9p this year. And this figure yields a chunky 2.9%. The good news doesn’t stop here, however, and an anticipated 7% earnings rise in fiscal 2019 underpins expectations of a 17p reward. As a result the yield steps to an even better 3.1%.

Safestore might be expensive, the firm dealing on a forward P/E ratio of 20.7 times. I reckon the company’s robust position in an expanding market merits this premium, though.

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.

Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Pendragon. 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.

More on Investing Articles

Investing Articles

The Standard Chartered share price leaps on FY dividend and buyback news. Time to buy?

An 8% jump for a UK-listed bank on 2023 results? That's what just happened to the Standard Chartered share price.…

Read more »

View of Tower Bridge in Autumn
Investing Articles

Can Lloyds shares get any cheaper?

Lloyds shares have fallen further following the release of the bank's 2023 results. This Fool senses now is a time…

Read more »

Aerial shot showing an aircraft shadow flying over an idyllic beach
Investing Articles

£7,000 of money to spare? Here’s how I’d aim to turn that into £1,000 in annual extra income

Christopher Ruane explains how he would aim to generate a four figure income to cushion his future, all with dividend…

Read more »

British union jack flag and Parliament house at city of Westminster in the background
Investing Articles

Is this stellar dividend growth stock the only no-brainer buy on the entire FTSE 100?

Picking shares requires careful thought and analysis, but this FTSE 100 growth stock appears to be pressing all the right…

Read more »

Investing Articles

I bought 422 Glencore shares in July and 232 in September. Here’s what they’re worth now

Glencore shares have had a rough ride leaving Harvey Jones out of pocket. Should he cut his losses or average…

Read more »

Man smiling and working on laptop
Investing Articles

Here’s why I’m investing most of my savings in FTSE 100 shares!

I think investing in FTSE 100 shares is one of the best ways that UK investors can make long-term returns.…

Read more »

Newspaper and direction sign with investment options
Investing Articles

When cheap markets meet favourable conditions, sentiment flips very quickly

London’s stock market is cheap — some sectors, even cheaper. Given a change in sentiment, the uprating could be substantial.

Read more »

Investing Articles

Empty Stocks and Shares ISA? I’d snap up these 3 stocks to start with!

Sumayya Mansoor explains how she would start to build wealth from scratch with an empty Stocks and Shares ISA and…

Read more »