While comparing price-to-earnings (P/E) ratios this morning, a lesser-known FTSE 250 stock caught my attention.
With a low P/E ratio of 8.8 and a meaty 5.6% dividend yield, I was intrigued. Either it’s a solid dividend stock with strong earnings… or a crashing share price has pushed the yield up and the P/E down.
I had to find out.
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A lender-turned-challenger bank
Paragon Banking Group (LSE: PAG) may seem like the latest in a long line of UK challenger banks. But it’s far from a new player on the market.
Once solely a buy-to-let (BTL) lender, Paragon received a UK banking license in 2014. It now serves over 1.5m customers with £15bn in loans.
Like most challenger banks, it differs from high street banks in that it has no branches. Rather than offer typical savings accounts, it focuses on specialised lending for landlords, SMEs and commercial equipment.
CEO Nigel Terrington has helmed the bank for almost 20 years, having initially helped it navigate the early 90s recession. Having held the position so long speaks volumes to his commitment — but how has the bank fared in that time?
Slow and steady growth
Surviving both the 90s recession and the 2008 Financial Crisis, Paragon’s made steady progress. It’s up 77.6% in the past decade, equating to annualised growth of 5.93%. It recovered rapidly after Covid, climbing from £2.57 a share to a five-year high of £8.03 last month (6 December).
But past performance is no indication of future results. If the housing market slips, mortgage lenders could take a hit. Even mildly rising interest rates could put significant pressure on the company’s profits.
What’s more, it’s facing up against the big boys like Lloyds and NatWest. Specialist lenders have a place but the growth potential’s limited. During tough economic times, consumers tend to prefer established brands over lesser-known ones.
What’s the alternative?
When assessing a stock, it’s equally important to look for reasons NOT to buy it, rather than vice-versa. One of the key reasons not to invest in one stock is the potential to better allocate capital elsewhere.
Looking at the UK’s diversified finance sector, one key competitor sticks out: OSB Group. Like Paragon, it offers BTL and commercial mortgages in the UK along with additional services like savings accounts.
Both share similar market-caps (£1.5bn) and profit margins (40-50%) but OSB enjoys considerably higher revenue and earnings. It also has a slightly higher 10-year annualised growth rate of 6.4%.
Most notably, OSB has a lower P/E ratio (3.8) and a higher dividend yield (8.3%). Given that those were my initial criteria, it seems OSB’s the obvious choice.
However, the share price is down 20% in the past six months leading to the inflated yield. What’s more, it has a short dividend history, limiting any assurance of future payments.
Final thoughts
Despite the lower yield, Paragon may be more reliable for dividends. That said, it offers fewer diversified products, leaving it more exposed to the housing market.
Overall, with strong earnings growth and a history of stable management, I think it’s a stock worth considering. I’m not currently looking to diversify more into finance but it’s certainly one I’ll keep an eye on.
