One dividend stock I’d avoid and what I’d buy instead

This stock may not be as cheap as it looks. But will you fall for its seductive dividend yield?

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I last looked at automated iron foundry and machining company Castings (LSE: CGS) as long ago as October 2015. Back then, as usual, the idea was to try to figure out whether the stock could make a decent investment or not.

It was hard for me to work up enthusiasm for the share. There didn’t seem to be much scope for spectacular growth rates, and I was worried about the inherent cyclicality in the operation as well.

A worrisome, volatile holding period

The company exports much of its product to vehicle manufacturers, and I said in 2015: “Owning the shares now is fine if the economic up-leg continues, but I wouldn’t want to be holding Castings if a downturn hits the industry.” My guess back then was that many shareholders were attracted to the stock because it appeared to be cheap, but I argued that “through the lens of cyclicality, Castings might not be as cheap as it looks.”

For the record, in October 2015 the share price stood at 436p and the forward-looking price-to-earnings rating one trading year ahead to March 2017 stood at 10.5. The anticipated dividend yield was 3.4%.

Today, the share price stands close to 442p, the forward-looking P/E rating to March 2020 is almost 14 and the anticipated dividend yield is just under 3.2%. Over the past three years and eight months, revenue, earnings, cash flow, and the dividend have all been volatile and the share price dipped as low as about 350p in March 2019 before bouncing back recently.

If you’d held since my previous article, you’d have collected just under 76p in ordinary and special dividends and made about 6p on the share price for a total return of about 82p, which works out at an overall return of around 19%.

Given all the cyclical risk you’d have taken on, I think that kind of return is low for a hold of more than three-and-a-half years. And we haven’t even seen a major slump in the industry yet. As time passes, arguably, the risk involved with holding now is even greater than it was.

A lacklustre outlook statement

The company delivered its full-year results report today. Revenue increased by almost 13% compared to the previous year and earnings per share moved up around 12%. The directors increased the total dividend for the year by just over 1.9% to 14.78p and also declared a special dividend of 15p. We could look at the dividend yield as being about 6.7% this year, although special dividends are not guaranteed in the future. Indeed, the last special dividend was paid in 2016, so it’s an intermittent occurrence.

I think the outlook statement is informative and here it is in full: “It appears at the present time our order book is sound and schedules remain stable. In particular demand for commercial vehicles is currently strong and it is hoped this trend will continue.” To me, the tone and language of that statement suggest that the directors are aware they have little control over the macro-economic cycles governing the outcomes for their business. This one is not for me and I’d rather invest in a tracker fund than take the individual company risk.

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.

Kevin Godbold has no position in any share 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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