Why I’d shun this FTSE 250 dividend growth stock and buy this FTSE 100 income share instead

This FTSE 100 (INDEXFTSE: UKX) share appears to offer stronger dividend potential than a FTSE 250 (INDEXFTSE: MCX) income peer.

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Dividend growth tells investors a great deal about the prospects of a company. A fast-growing dividend suggests that the business has a confident outlook, as well as improving finances. In contrast, a company with limited dividend growth may be retaining cash in anticipation of a challenging period.

However, with the FTSE 100 and FTSE 250 both having made gains in recent years, the valuations of some dividend growth shares seem to be excessive. With that in mind, here is one FTSE 250 dividend share that seems overpriced to me, as well as a FTSE 100 income stock which I feel could be worth buying for the long term.

Improving performance

The FTSE 250 share in question is Hilton Food Group (LSE: HFG). The specialist food packing business recorded a positive performance in the 28 weeks to 15 July, with it being in line with management expectations. It has continued to grow the business through additional volumes, as well as through close cooperation with retail partners.

In the last four years, the company has grown dividends per share at an annualised rate of 10%. This is an undeniably impressive performance, and shows that the company has sought to reward its shareholders at the same time as profitability has increased. And with the stock having a payout ratio of around 50% of earnings, further dividend growth could be ahead.

But despite its rapid dividend growth, Hilton Food Group appears to lack a margin of safety. It trades on a price-to-earnings (P/E) ratio of around 26, which suggests it is priced for rapid growth. But since its bottom line is due to rise by ‘only’ 8% this year and by 6% next year, it could prove to be a disappointing performer when it comes to capital returns.

Income potential

In contrast to that one, the income investing prospects of FTSE 100 water services company Pennon (LSE: PNN) seem to be highly appealing. The stock has a dividend yield of around 5% at the present time, and is due to raise dividends by 7% in the next financial year. Its stable track record of dividend growth suggests that inflation-beating income returns could be ahead over the medium term. This could appeal to a wide range of investors even though inflation has cooled in recent months.

While regulatory risk remains high across Pennon’s industry, the company appears to offer defensive characteristics relative to the rest of the FTSE 100. Although the current bull market may have a long way still to run, risks such as a trade war could mean that investor sentiment declines over the short run.

In such a scenario, the company could become increasingly popular due to its lower positive correlation with the performance of the wider economy. And with Brexit set to take place next year, it could offer a relatively certain income outlook in uncertain times.

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.

Peter Stephens owns shares of Pennon Group. The Motley Fool UK has recommended Pennon Group. 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.

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