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Don’t waste money on banking stocks. These dividend shares could smash the FTSE 100

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More than 10 years after the failure of Lehman Brothers, several of the UK’s largest banks are still struggling to win back investor confidence. I’m starting to lose patience.

I still own a few banking shares, but I’m starting to look for financial stocks to replace them in my portfolio. Increasingly, I feel that more attractive long-term returns are available elsewhere in the financial sector.

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New rules hit revenue

Shares of online trading firm CMC Markets (LSE: CMCX) were down by 9% at the time of writing, following a profit warning this morning.

The company says that new European regulations limiting the amount of leverage available to retailer traders means that full-year revenue is expected to fall by about 20%, below previous guidance of 10%-20%.

In turn, this means that profits for the year are also likely to be lower than expected.

A buying opportunity?

I suspect these new rules will turn out to be a short-term headwind to which the company and its customers will adapt.

For example, CMC is already generating more than 50% of its UK and European revenue from professional and institutional clients, who are exempt from the new rules. And like its larger rival IG Group, CMC is also using its trading infrastructure to expand into stockbroking, via a partnership with Australia’s ANZ Bank.

Chief executive Peter Cruddas still has a 63% shareholding in this highly profitable business, which he founded in 1989. In my view Mr Cruddas is likely to work through these latest challenges and return the business to growth.

After today’s fall, the shares trade on about 13 times forecast earnings and offer a yield of more than 5%. I think that’s too cheap for a business which generated an operating margin of 32% last year. I’ve added the stock to my buy list for further research.

Expert management

Another small financial stock which benefits from owner-management is car loan specialist S & U (LSE: SUS). Chairman and vice-chairman Anthony and Graham Coombs have a combined 24% stake in this firm, which was founded by relative Clifford Coombs in 1938.

The firm published its half-year results today, showing continued strong growth. Group revenue rose by 23% to £44.5m during the six months to 31 July, while pre-tax profit was 17% higher at £16.7m.

Group receivables — a measure of S & U’s loan book — rose by 22% to £279.8m, including continued growth at the firm’s new property loan business, Aspen Bridging.

What could go wrong?

Bad debt levels at the firm’s Advantage car loan business averaged 24.7% over the 12 months to 31 July, compared to 21.9% at the end of January 2018.

These figures seem high but appear to be fairly normal in the sub-prime sector, where borrowing costs are high to reflect the likelihood of default.

The company says that it’s tightened underwriting standards and is starting to see impairment rates fall back towards historical levels. It’s also worth noting that return on average capital employed remained high, at 15.4%, during the first half. That’s only slightly lower than the 16.4% seen last year.

The stock trades on just 10 times forecast earnings with a dividend yield of 4.7%. I’d be happy to buy the shares at this level.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended S & U. 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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