Why I think this FTSE 100 dividend stock could help to double your State Pension

This monster dividend growth stock is a FTSE 100 (INDEXFTSE:UKX) star, says Roland Head.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Finding companies that can beat the market over long periods isn’t easy. But if you want to build the six-figure fund needed to double your State Pension, I believe that focusing on long-term winners is one of the best ways to invest.

One technique favoured by many successful investors is to look for companies with high profit margins and a clear competitive advantage. Known as quality stocks, these companies can often grow sustainably for many years.

Motoring ahead

In my view, FTSE 100 car marketing group Auto Trader Group (LSE: AUTO) is a good example of a quality business. More than 80% of the UK’s automotive retailers advertise on autotrader.co.uk, which receives about 55m visits per month.

Over the 12 months to 30 September, the group generated an operating profit of £232m on sales of £341.9m. That gives an operating profit margin of 67.8%, which is exceptionally high.

This is special

High profit margins are great, but they don’t tell the whole story of a firm’s profitability. To understand this, we also need to consider how much capital investment is needed to generate these profits.

Auto Trader doesn’t need expensive factories, warehouses or transport infrastructure. It just needs some offices and a fairly small number of staff. Capital investment in the business is low.

The combination of high profit margins and low capital intensity results in a very high return on capital employed (ROCE).

My sums show that Auto Trader generated a ROCE of 65% over the 12 months to 30 September. That means for each £1,000 of capital employed in the business, it generated an operating profit of £650. That’s extremely high.

Keep buying?

Auto Trader’s high returns mean that it generates a lot of surplus cash. Some of this is returned to shareholders as dividends, but an increasing amount is being used to buy back and cancel the firm’s own shares.

The advantage of this approach is that it boosts future earnings growth and reduces the number of shares on which dividends must be paid. This supports more rapid dividend growth.

Auto Trader shares may not seem cheap, with a forecast P/E of 20 for 2019/20 and a dividend yield of 1.7%. However, earnings per share have risen by almost 50% since the group floated in 2015, and the dividend is growing at more than 10% per year.

I think further gains are likely and rate the shares as a long-term buy.

I’m avoiding this growth stock

In contrast to Auto Trader, online electrical retailer AO World (LSE: AO) faces brutal competition from larger rivals.

Trading figures released today suggest growth may be slowing. Group sales rose by 8.2% during the final quarter of 2018. That’s less than half the 16.6% sales growth reported for the same period in 2017.

That’s a potential concern, as I think one of AO’s most serious problems is that it’s not really big enough. The group’s sales are less than 10% of those made by market leader Dixons Carphone.

What happens next?

In fairness, AO’s UK business is profitable. However, these slim profits are being spent on a loss-making effort to expand into Europe. In my view, the company should scrap its European ambitions and focus all its efforts on the UK.

Doing this could give shareholders a chance to earn reasonable returns. However, another year of losses is forecast for 2018/19. I think this stock is seriously overvalued and best avoided.

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 owns shares of Dixons Carphone. The Motley Fool UK has recommended Auto Trader. 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.

More on Investing Articles

Investing Articles

How I’d aim to earn £16,100 in passive income a year by investing £20k in a Stocks and Shares ISA

Harvey Jones is building a portfolio of high-yielding FTSE 100 dividend stocks that should give him a high and rising…

Read more »

Investing Articles

Down 8% in a month! The BP share price is screaming ‘buy, buy, buy’ at me right now 

When crude oil falls, the BP share price invariably follows. Harvey Jones is wondering whether this is the right point…

Read more »

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

Could the 9.8% M&G dividend yield get even bigger?

Christopher Ruane reckons that, although the M&G dividend yield is already close to a double-digit percentage, it could get better…

Read more »

Investing Articles

How much passive income could I earn by putting £380 a month into a Stocks and Shares ISA?

Christopher Ruane explains how he'd aim to turn a Stocks and Shares ISA into four-figure passive income streams each year.

Read more »

Investor looking at stock graph on a tablet with their finger hovering over the Buy button
Investing Articles

2 passive income stocks I’m buying before an interest rate cut

With the market expecting interest rates to fall in August, time might be running out for investors looking to buy…

Read more »

Investing Articles

If I’d bought Rolls-Royce shares a year ago, here’s what I’d have now

Rolls-Royce shares have been the big FTSE 100 success story of the past 12 months and more. And there's still…

Read more »

Young female analyst working at her desk in the office
Investing Articles

If the Dow’s heading for 60,000 by 2030, can the FTSE 100 index hit 12,000?

Strategist Ed Yardeni predicts a 50% rise for America’s Dow Jones Industrial Average over six years. Can the FTSE 100…

Read more »

Investing Articles

Is the National Grid share price a once-in-a-decade opportunity?

The National Grid share price looks like a bargain. But there’s much more for investors to think about than a…

Read more »