Why I’d sell this overpriced FTSE 250 share and buy this FTSE 100 dividend instead

This FTSE 100 (INDEXFTSE:UKX) share appears to offer greater income potential than a FTSE 250 (INDEXFTSE:MCX) stock that reported on Friday.

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With the FTSE 100 and FTSE 250 having risen significantly in recent years, it is unsurprising that a number of shares are trading on high valuations. As a result, it is becoming more challenging for investors to obtain wide margins of safety when purchasing stocks for their portfolios.

With that in mind, here is a FTSE 250 share that appears to be overpriced in spite of improving recent performance. It could be worth selling in favour of a FTSE 100 stock that seems to offer an enticing income outlook.

High valuation

Reporting on Friday was international home repairs and improvements business Homeserve (LSE: HSV). Its performance in the traditionally quieter April-July period has been positive, with it trading in line with expectations. It remains on track to deliver good growth in the 2019 financial year, and has attractive opportunities in all of its geographies. It expects continued strong organic growth in North America, while its acquisition pipeline could help to accelerate its sales performance.

Looking ahead to the next two financial years, Homeserve is forecast to post a rise in earnings of 9% and 11% respectively. This is an impressive rate of growth, which normally would be highly appealing to a potential investor. However, with the stock trading on a price-to-earnings (P/E) ratio of around 29, it appears to be fully valued at the present time.

Certainly, there is scope for further growth to be achieved in future years. But with such a narrow margin of safety, the investment appeal of Homeserve seems to be somewhat limited.

High income return

By contrast, the investment potential of home and motor insurance specialist Direct Line (LSE: DLG) seems to be high. The company has a dividend yield of over 9% at the present time, which makes it one of the highest-yielding stocks in the FTSE 100. Although this figure includes special dividends, the performance of the business is set to remain robust over the next couple of years, with earnings growth forecast for both the current year and next year.

With the motor insurance industry appearing to successfully adapt to changes in the Ogden discount rate, its prospects appear to be bright. Direct Line has been able to grow its partnership portfolio in recent quarters, while its performance in the first quarter of the current year showed that it is operationally sound. Further investment in its digital capabilities could lead to an improvement in its financial performance over the medium term.

Since the stock trades on a P/E ratio of around 13, it appears to offer good value for money. With the FTSE 100 and FTSE 250 being close to record highs, it is all too easy to buy shares that are overpriced. However, Direct Line’s income return and capital growth could be impressive in future years.

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 Direct Line Insurance. The Motley Fool UK has recommended Homeserve. 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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