Forget the cash ISA! I think this FTSE 250 dividend stock could provide a reliable 5.8% income

Roland Head looks at two FTSE 250 (INDEXFTSE:MCX) dividend stocks with attractive income potential.

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Cash ISAs offer a tempting combination of tax-free safety and interest income. But the reality is that the interest rate on most ISAs is still below 1.5%. That means the value of your cash won’t even keep pace with inflation.

To be honest, this doesn’t seem like much of a reward for your hard work.

Although I’d always aim to keep some cash available for rainy days, I prefer to put most of my savings to work by investing in dividend stocks. This tends to provide a higher level of income, and the potential for long-term capital gains.

Today I want to look at two FTSE 250 dividend stocks from my watch list.

Signs of improvement

Cycling and car accessory retailer Halfords Group (LSE: HFD) needs no introduction. But the firm’s after-tax profits have fallen in each of the last four years, as rising costs and a changing mix of products have put pressure on margins.

Thursday’s half-year results from the company suggest more of the same. Although like-for-like sales rose by 2.5% and group revenue was 1.9% higher at £599.9m, underlying pre-tax profit fell by 17.1% to £30.5m.

The company said that strong sales of electric bikes, tools, dash cams and cleaning products helped to offset a slow start to the year. Sales of car repair and maintenance services through the Autocentres business also improved, rising by 3.3% on a like-for-like basis.

Buy, sell or hold?

Halfords’ underlying operating margin was 5.3% during the first half of the year, down from 6.5% during the same period last year. That’s a disappointing result in my view, although today’s figures do appear to be broadly in line with broker forecasts.

One highlight was free cash flow of £34m, up from £30m for the same period last year. Cash generation has always been a strength of this business, and it’s good to see this continue despite lower profit margins.

The shares are priced for a low-growth future, trading on just 10.5 times 2019 forecast earnings. This year’s forecast dividend of 18.1p per share looks affordable to me and would give a yield of 5.8% at the current share price.

In my view this out-of-favour retailer could be worth considering as an income buy.

Better than expected

Sales of new cars in the UK have fallen by 7.2% so far this year, according to industry figures. A slump in diesel sales is mainly to blame, but so too are supply bottlenecks caused by the new WLTP emissions testing regime.

Despite these headwinds, dealership group Lookers (LSE: LOOK) expects to deliver results in line with previous expectations this year. Indeed, the firm said that a shortage of supply in September enabled it to increase profit margins on new cars sold last month.

Although overall gross profit from new car sales fell by 5% during the nine months to 30 September, gross profit from used cars rose by 10% and after-sales profits were 6% higher.

In a statement to investors, management pointed out that new car sales are still at historically high levels, despite this year’s fall.

In my view, this suggests further falls in new car sales are possible. But if you have a more optimistic outlook, then Looker shares could be worth a look. Trading on 7.3 times forecast earnings with a 4% yield, they don’t look expensive to me at the moment.

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.

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