Forget the Metro Bank share price! I’d buy this FTSE 250 dividend growth stock today

Roland Head explains why he’s avoiding Metro Bank plc (LON: MTRO) and buying a different FTSE 250 (INDEXFTSE: MCX) financial stock.

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The Metro Bank (LSE: MTRO) share price took another tumble this week, after the bank issued a dismal set of half-year results and said it would start looking for a new chairman to replace founder Vernon Hill.

However, despite recent problems, Metro’s figures appear to show that the bank is now profitable, growing and adequately capitalised. If that’s true, then the shares might soon find support.

This view seems to be gaining strength with hedge fund investors who’ve previously been betting that the stock would fall. The percentage of the firm’s stock loaned out to short sellers has dropped from 12.5% in June to 5.2% today.

Indeed, forecasts produced by City analysts suggest that Metro Bank’s profits could bounce back next year, rising to a new record high.

Is it time to start buying this troubled challenger bank?

I’m still worried

News that savers have withdrawn £2bn from Metro Bank since the start of the year concerns me. This run of withdrawals has left Metro Bank with loans of £14,989m, but deposits of just £13,703m.

Although this is allowed, it’s not ideal. Metro Bank’s own target is for loans to be maintained at 85%-90% of deposits. When this ratio rises above 100%, it means the bank has loaned out more cash than its received in deposits.

Any rise in bad debts or a further run of withdrawals could leave the bank forced to raise cash from other lenders or even from shareholders. But in a situation like that, lenders might be wary about lending to Metro. That would push up the cost of any debt.

Metro Bank doesn’t expect its loan-to-deposit ratio to fall below 100% until at least 2020. I see this as an extra risk that’s likely to put further pressure on the bank’s profit margins.

Despite this, the shares are still trading on 19 times 2019 forecast earnings, and 16 times 2020 forecast earnings.

In my opinion, this suggests that MTRO stock is priced for strong growth and no further problems. That seems very optimistic to me. In my view, this remains a stock to avoid.

A financial stock I’ve bought

One financial stock I own myself that’s much more profitable than any UK bank is spread betting and CFD trading firm IG Group Holdings (LSE: IGG).

Since August last year, companies in this sector have been operating under new EU regulations which restrict the amount of leverage — or credit — they can offer retail customers.

However, these restrictions don’t apply to professional traders, who form a large part of IG’s customer base. To give an idea of how profitable these are, IG’s professional clients in the EU generated fee income for the business of nearly £27,000 each last year.

A very profitable business

IG’s latest results show that it generated an operating profit margin of 39% and a return on equity of 19% last year. Although earnings fell by 30% due to the new rules, chief executive June Felix is confident she can return the business to growth.

In the meantime, IG’s strong cash generation suggests to me that the dividend can be maintained. At 43p per share, this gives the stock a tempting yield of 7.5%.

This business will always carry the risk of being disrupted by new regulations. But in my view it’s the best of its kind and should be a good dividend growth buy at current levels.

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 IG Group Holdings. 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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