Is this 5%-yielding dividend stock a brilliant bargain or just a value trap?

Massive yields, dirt-cheap earnings multiples. What’s not to like? Royston Wild lifts the lid on a dividend ‘hero’ and wonders whether it deserves its reputation.

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Car dealer Pendragon (LSE: PDG) has proved itself to be a dream drive for income investors thanks to the rate at which it has raised dividends in recent years. More specifically it’s jacked up annual payouts by triple-digit percentages over the past half a decade.

The business has seen its share price spike to six-month highs in recent sessions, and my Foolish colleague Harvey Jones is one of those that believes the road ahead remains an exciting one. But whil he believes that the used car market provides plenty of profits opportunities for Pendragon, I am not so sure.

That said, it is pretty cheap at the present time. Do I think it is it worth a punt?

Sales slowdown

I’ve written long and hard about the impact that Brexit-related uncertainty is having on the British auto sector. This is not the only problem facing the likes of Pendragon, though, as changes to the way lawmakers test carbon dioxide emissions (and other pollutants) from cars is also denting its profits outlook.

Indeed, in mid-October Pendragon advised that the introduction of new legislation known as the Worldwide Harmonised Light Vehicle Test Procedure “has caused significant new vehicle supply disruption which gives us cause for concern over the coming months for new vehicle sales and profitability.”

As if this wasn’t scary enough for its shareholders, the retailer followed the worrying statement with a profit warning in which it forecast full-year profit before tax of £50m, down from above £60m last year.

The market should be braced for further downgrades too, given that sales deceleration is picking up traction. Like-for-like sales at Pendragon dropped 7.2% in the three months to September, it advised, worsening sharply from the 0.9% decline punched in the first six months of 2018, with demand tanking in both the new and used car segments.

Low multiples, big yields. Is it a buy?

Right now Pendragon deals on a forward P/E ratio of just 9.9 times, caused by the expected 19% earnings decline that the City has committed to paper. That said, I’m not tempted by this low reading due to the likelihood of additional estimate slashing for the near term, as well as the probability that the anticipated 21% bottom-line rebound for 2019 will be put to the guillotine too.

In light of the worsening profits outlook, I also reckon investors should be braced for Pendragon to slash the dividend much more than is currently being forecast (a 1.4p per share reward is predicted, down from 2017’s 1.55p payment). Naturally, this means that the company’s inflation-bashing 5.3% yield holds little appeal for me either.

In fact, the news flow over the past couple of weeks has reinforced my view that the small-cap is a rock-solid sell right now. The sell-off across financial markets in recent weeks leaves plenty of dirt-cheap dividend darlings for stock pickers to pile into. Pendragon is just an investment trap in my opinion, and should be avoided like the plague.

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.

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