The IAG (LSE:IAG) share price is up a respectable 15% this year due to roaring travel demand. With the Portuguese government putting its flag carrier, TAP, up for sale, I explore whether a potential acquisition could send IAG shares rallying higher.

Portugal TAPs out

IAG stock remains 66% below its pre-pandemic levels as the company claws its way back to its glory days. Revenue for the firm recently hit an all-time high. Even so, higher profits remain a challenge due to high fuel and labour costs. Subsequently, this has been weighing down IAG shares and preventing them from fulfilling their potential despite the relentless demand for travel. But with TAP now up for sale, this could be an opportunity for IAG to boost its share price.

For context, the Portuguese flag carrier earned €3.58bn in revenue in 2022. Meanwhile, load factors and passenger capacity have increased meaningfully since last year. As a result, TAP’s capacity, revenue per seat kilometre (RPK), and revenue per passenger trump its competitors as of Q2.

More encouragingly, the carrier’s operating profit turned positive, up from the €150m loss it incurred the year before. Therefore, this leaves room for more growth. This is especially the case if it can integrate its operations with IAG, as it would reduce costs due to integrated efficiencies. Thus, it’s no wonder IAG CEO Luis Gallego is eager to acquire TAP as he sees it being a key catalyst to boosting the share price.

Tapping into reserves

Having said that, the potential acquisition isn’t as straightforward for the Anglo-Iberian conglomerate. Doing so would require a substantial amount of funding. Although IAG’s cash reserves are substantial, it still has a mountain of debt to contend with considering its net debt position of €7.61bn.

Plus, given that TAP isn’t a public-listed company, ascertaining its enterprise value isn’t particularly straightforward. Nonetheless, the Financial Times estimates it could be worth approximately €1bn. But with Portuguese officials planning to keep a minority stake in the group, IAG may only need to fund half of its enterprise value.

Still, funding an acquisition via its cash reserves is a risky option with IAG’s debt position. As such, the more likely route the consortium might take is to issue more shares. Nevertheless, this could be a double-edged sword, as it could dilute IAG’s earnings per share (EPS) and cause the stock to decline. But considering IAG’s decent return on capital employed of 14.1%, shareholders may not mind seeing their positions getting diluted for bigger potential returns.

Can the IAG share price rise further?

Regardless of the outcome, it’s still relatively safe to say that IAG shares have quite a clear path to continue rising in value. After all, Barclays, Bernstein, Deutsche, RBC, Goldman Sachs, Liberum, and Bank of America all expect the shares to hit 200p or higher in the next 12 months.

Moreover, taking bookings data for air travel into account while capacity continues to ramp up, I’m confident that IAG can continue performing; even more so if it can acquire TAP at the right price. There are risks, of course, including labour and fuel costs. But with a healthy fuel hedging strategy, and the potential to consolidate another airline at a good price, the IAG share price could rise to £2 in no time.

The post Can the IAG share price rise 33% and hit £2 by acquiring TAP? appeared first on The Motley Fool UK.

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Bank of America is an advertising partner of The Ascent, a Motley Fool company. John Choong has positions in Barclays Plc. The Motley Fool UK has recommended Barclays Plc. 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.

Airline stocks have been flying since recovering after travel restrictions were lifted. However, both Wizz Air (LSE:WIZZ) and easyJet (LSE:EZJ) have seen their shares stall after rapid climbs earlier this year. Here’s why and which stock could be the better buy, in my opinion.

The case for Wizz Air shares

Engine troubles have arguably been the main driver for the decline of Wizz shares. An ongoing issue with its Pratt & Whitney (P&W) engines has resulted in the airline having to ground several of its aircraft. Consequently, Wizz is expected to reduce up to 10% of its capacity. It’s no wonder investor sentiment has turned more sour for Wizz shares than easyJet’s in recent months, as the latter’s fleet doesn’t run on P&W engines.

Additionally, management’s decision not to hedge its fuel (a risk management strategy to protect against rising fuel costs) last year ultimately came back to bite the group. As such, the board recently opted to begin hedging its fuel again, although this has triggered numerous questions as to how effective the strategy will be. That’s because, unlike its peers, Wizz has hedged a lower portion of its fuel for the year, and at a higher spot price.

Having said that, Wizz has seen a strong tailwind in rampant travel demand — in July, it reached a new record-high number of passengers flown, with over 6m passengers travelling that month. Therefore, the case for buying Wizz Air shares over easyJet would be the fact that there’s more growth potential to realise. If the Hungarian firm can circumvent its current challenges successfully, its shares could rise by as much as 82%, according to analysts’ consensus, as indicated by the graph below.

The case for easyJet shares

While the easyJet share price has been on a descent as well, analysts’ estimates for the orange-branded airline have gone in the opposite direction. This could present a buying opportunity as the projected earnings don’t support the current sour market sentiment. In fact, easyJet’s FY23 and FY24 earnings per share (EPS) estimates have grown 12% and 9%, respectively, over the past 90 days.

This shouldn’t come as a surprise, as third-party travel data continues to show that travel in and around Europe remains hot. And with discretionary spending also staying resilient for travel, easyJet will undoubtedly benefit from this.

More interestingly, the travel operator is also planning to expand its fast-growing Holidays business. With the holiday package business already expected to generate more than £100m in pre-tax profit this year, a Reuters report now indicates that the budget airline aims to expand its market to France and Germany. Entering such a massive market would only do the easyJet share price wonders, with more upward revisions surely to come.

Which is the better buy?

So which of these two airlines is the better stock to buy? Well, this depends on an investor’s risk tolerance. Wizz Air shares do offer a higher potential for higher returns. That said, there’s no guarantee if or when it can get through its current issues.

easyJet shares offer a lower share price growth potential. Nevertheless, I see it as a much safer bet with a much more robust balance sheet, all while boasting a promising line of earnings appreciation. For that reason, I reckon easyJet would be the better buy and would use this current period of weakness to increase my position.

The post Wizz Air vs easyJet shares – which is the better buy? appeared first on The Motley Fool UK.

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John Choong has positions in easyJet Plc. 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.

Britain’s largest retailer is set to report its interim results this week. Tesco (LSE:TSCO) shares have been trading sideways since their Q1 update. So, here’s what investors can expect and whether I should rush to buy the stock before a potential rally.

Points to consider

When Tesco last reported its Q1 trading update in June, the board’s outlook for FY24 remained unchanged. That was for retail adjusted operating profit of £2.6bn, retail free cash flow of £1.4bn to £1.8bn, and Tesco Bank operating profit of £130m-£160m.

This doesn’t come as a surprise as the cost-of-living crisis and lower food inflation act as headwinds to the company’s earnings. Therefore, it’s no surprise to see Tesco shares failing below their May peak of 285p.

Nonetheless, quite a bit has changed since then, and encouraging trends have begun developing. Most prominently, food inflation has come down rather meaningfully. Although this limits Tesco’s revenue growth, this serves to be a net benefit because of a more critical development — real wage growth among its customers. I believe this will be Tesco’s main catalyst in driving its shares up moving forward.

What to expect

With wages now trending above inflation, there’s naturally been an uptick in disposable income. This should result in three favourable outcomes for the firm.

First of all, fewer shoppers may feel the need to trade down to cheaper supermarkets and lower-margin products. Second, more customers may begin purchasing higher-margin discretionary items once again, thereby growing Tesco’s margins. In fact, CEO Ken Murphy shared on the earnings call that he expects gentle trading up in discretionary products as cost pressures decrease and wages increase.

This thesis isn’t unfounded either. Kantar’s latest grocery reports have seen Tesco outperform its traditional competitors in sales growth. The grocer grew its sales in August and September, by 9.5% and 9.1%, respectively. Meanwhile, budget retailers Aldi and Lidl saw their sales growth slowing (albeit still beating Tesco), dropping to 16.6% in September from 20.5% in August.

I have an optimistic view of the group’s interim earnings and wouldn’t be surprised if Murphy upgrades its outlook for the year. That said, management might opt to maintain guidance to fend off potential ‘profiteering’ claims. Either way, I expect Tesco shares to rise on the back of a robust set of H1 numbers, with an improvement in gross margin due to falling wholesale commodity prices. Those numbers include:

• UK sales (ex. VAT, ex. fuel) to grow 13% to £22.68bn from £19.99bn
• Gross margin to improve 170bps to 7.0% from 5.3%
• Operating profit to drop 2% to £1.29bn from £1.32bn

Should I buy?

Tesco shares may seem overvalued with their price-to-earnings (P/E) multiple of 24.7. However, this is due to impairments relating to property disposals. On an adjusted basis, the stock actually trades at a more reasonable P/E of 12.1.

Given the promising developments and a strong share buyback programme, it’s no wonder analysts at large rate Tesco stock a Buy. I happen to echo the same sentiment as I expect the retail giant to achieve EPS of 23.10p for FY24, giving the stock a forward P/E of 11.4 with a price target of 300p. Of course, I could be wrong, but I’m confident that Tesco shares will generate meaningful returns over the long term. Thus, I’d buy the shares today if I had spare cash.

The post Should I rush to buy Tesco shares today? appeared first on The Motley Fool UK.

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John Choong has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco Plc. 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.

With Q3 earnings fast approaching, the investment cases for many companies could be set to change. As such, here are four standout FTSE 100 stocks I’d buy this month for long-term gains.

1. Lloyds

There seems to be light at the end of the tunnel for bruised and battered Lloyds (LSE:LLOY) shares. The stock rose by 8% in September, outperforming the FTSE 100. This came after positive inflation data gave investors hope the rate-hiking cycle may soon come to a halt.

This would be good news for the Black Horse bank. Fewer customers defaulting on loans or withdrawing deposits, would allow Lloyds to get back to growing its loan book and earnings.

Nonetheless, the road ahead is still bumpy. A recession could see its current rebound fall short. Still, Lloyds’ outlook is brightening. With the shares undervalued, now could be a prime time to buy into this banking giant.

2. Barclays

I’m aiming to buy more shares of Barclays (LSE:BARC), one of the FTSE 100’s cheapest banks. After an upgrade by Morgan Stanley, the stock is also showing glimmers of recovery. Like Lloyds, its shares also rose by 8% in September, and more gains could come as analysts warm up to Barclays’ underappreciated credit card business, strong consumer approach, and profitable deals.

Encouragingly, investment banking activity has also perked up this summer. This should bode well for earnings. With IPOs also reviving after slumping over the past year, green shoots are sprouting for Barclays’ investment banking arm.

Despite that, it’s worth highlighting that further rate hikes could see the stock pull back. But with the shares undervalued, now could be an opportune time to buy into what potentially could be the FTSE 100’s biggest winner over the next 12 months.

3. Marks and Spencer

Marks and Spencer (LSE:MKS) is another top stock to consider buying after the company got promoted to the FTSE 100 in September.

The retailer’s strong performance can be attributed to the dynamic duo of CEOs Stuart Machin and Katie Bickerstaffe for spearheading an incredible turnaround. The team has transformed M&S from a fading chain to an exciting retailer brimming with potential.

Machin also aims to grow M&S’ food market share by 1% yearly, possibly overtaking Waitrose as soon as 2024. Although the shares are approaching fair value, revamped stores and supply chain improvements suggest that the comeback story still has room to run.

4. Hargreaves Lansdown

Hargreaves Lansdown (LSE:HL) shares have been stuck at their year lows. But for dividend lovers, this could be a perfect buy-in point for one of the FTSE 100’s most reliable dividend payers. Even though it aced its latest earnings, the platform continues to get the cold shoulder despite its 5%+ dividend yield and reasonable valuation.

Bears are right to be worried about net interest income declining as rates decline in the medium term. However, the firm states that it can keep up its high level of interest income as long as rates stay above 2%. Combined with a commanding market share (41.8%), Hargreaves is positioned to ride a wave of investing enthusiasm once the stock market rebounds. If rates peak soon, the FTSE 100 could rally and bring Hargreaves Lansdown shares up with it.

The post 4 of the best FTSE 100 stocks to buy in October appeared first on The Motley Fool UK.

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John Choong has positions in Barclays Plc, Lloyds Banking Group Plc, and Marks And Spencer Group Plc. The Motley Fool UK has recommended Barclays Plc, Hargreaves Lansdown Plc, and Lloyds Banking Group Plc. 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.

The recent pandemic, geopolitical tensions, and cost-of-living crisis have significantly derailed the stock market’s upward trajectory. That said, there are signs that it’s starting to recover. As such, I believe this could be a once-in-a-decade opportunity to grow my wealth.

Room for optimism

There are a number of reasons for my optimism. First of all, the global economy is expected to grow again after a period of economic malaise. Several major economies like the UK and China continue to slump. But even so, it’s worth noting that the stock market is forward-looking. Therefore, a potential rally may begin well before these economies even officially declare an end to their sluggishness.

Second, interest rates are anticipated to fall over the next year or two. This should make it more attractive for investors to put their money back into the stock market once again.

Third, there are a number of exciting new technologies emerging. Most prominently, artificial intelligence (AI) has powered most of the stock market’s gains this year. These breakthroughs could lead to significant growth in the years to come as companies ramp up their spending on AI.

Still, there are always risks associated with investing. However, by conducting diligent research while investing over the long term through a diversified portfolio, investors can minimise their risks while maximising their chances of success.

A British bargain

One of the most attractive things about the UK stock market right now is that it is relatively cheap. This is because the FTSE 100 has been trading sideways since the start of 2023. To make things sweeter, Goldman Sachs has even stated that UK shares currently trade at a massive 45% price-to-earnings (P/E) valuation discount compared to US stocks.

Thus, investors can currently buy UK equities at much lower prices than their US counterparts. This could present a significant opportunity for investors who are looking for value. This is especially the case in a number of undervalued sectors such as financials.

The sector has been hit hard this year due to the collapse of several regional banks across the Atlantic. Nonetheless, there are now signs that banks are starting to recover. After all, their capital bases remain robust while profits continue to flow in. So, if the economy continues to grow, financial stocks like Lloyds and Barclays could be well-positioned to outperform the market.

Is the stock market risky?

It should go without saying that there are always risks when it comes to investing in the stock market — and one of the biggest risks is a potential recession. This could result in a sharp selloff in stock prices. Another risk to consider is sticky inflation. This could see interest rates rise to a higher level, and make it more expensive for companies to borrow money, consequently affecting their profits.

Nevertheless, 2023 could still be a once-in-a-decade opportunity to build wealth through the stock market. The global economy is starting to grow again. Plus, the interest rate outlook is improving as inflation falls. And most importantly, the UK stock market remains relatively cheap. On that basis, I’ll be taking this chance to grow my wealth by buying more UK shares in the coming weeks and months.

The post 2023 stock market: a once-in-a-decade opportunity to build wealth appeared first on The Motley Fool UK.

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John Choong has positions in Barclays Plc and Lloyds Banking Group Plc. The Motley Fool UK has recommended Barclays Plc and Lloyds Banking Group Plc. 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.

UK shares are currently trading at their biggest discounts to global peers in over a decade. As a result, investors may have an extremely rare opportunity to capitalise on undervalued stocks before the next bull run in the stock market.

Are UK shares on a discount?

According to Goldman Sachs, UK shares are currently trading at a massive discount. Data from the investment bank shows that, on average, British stocks are trading at a 45% discount compared to their US peers. Even after adjusting for differences in sector composition between the two markets, the discount remains an enormous 30%. This is the largest gap since the early 1990s.

Nonetheless, there are several factors to help explain why this is the case. These include Brexit, a strong US dollar, and pervasive investor scepticism regarding the growth prospects for Britain. However, with valuations now at such extreme lows, a substantial amount of negativity appears to already be priced in. This sets up a significant amount of room for UK-based stocks to rise in value once sentiment begins to improve.

More lucratively, UK companies are famous for their dividends and stock buybacks. Goldman Sachs projects the total shareholder yield from UK shares now sits at around 6% currently. Thus, this presents investors with an opportunity to earn ample passive income while waiting for eventual capital gains.

Early signs of life?

Recent fund flow data reveals early signs of renewed investor interest in UK shares after years of negative sentiment. According to Bank of America, last week UK equity funds experienced the largest inflow in an entire year. While the flows were driven by passive index-tracking funds rather than active stock-picking strategies, it still suggests that the extreme pessimism the UK stock market has suffered may be potentially starting to shift.

More promisingly, surveys show that global fund managers remain heavily underweight in UK shares. This means that there’s still a substantial amount of money remaining on the sidelines. This could change as fund managers begin rotating into the UK market if the economy and geopolitical backdrop show meaningful improvements. More crucially, this could boost the share prices of many FTSE 100 names.

A generational opportunity?

That said, successfully capitalising on this opportunity will require proper timing and patience. By most accounts, a peak in interest rates accompanied by a sustained decline in volatility is likely needed before UK shares can mount a durable breakout into a new bull market.

Additionally, there’s still a threat of a UK recession along with ongoing geopolitical tensions. This could delay or derail the stock market’s recovery. But beyond that, structural issues in the country remain. Issues like weak productivity may continue capping the potential for domestically-oriented UK companies.

Even so, investors still have a rare opportunity today to buy top-quality UK shares at historically low prices. This could potentially set up the prospect of strong multi-year returns.

Therefore, investors with long time horizons and the temperament to pound-cost average could gradually accumulate UK shares at today’s levels and generate handsome rewards over the next decade. Still, patience and discipline will be required in order to realise the potential of this once-in-a-decade opportunity.

The post A once-in-a-decade opportunity to buy UK shares before the next bull market appeared first on The Motley Fool UK.

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Bank of America is an advertising partner of The Ascent, a Motley Fool company. John Choong 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.

Special stocks with the potential to generate truly explosive returns are rare. This is especially the case with many UK shares where growth is notoriously low. But with the prospect of growing my money by as much as 65% over the next year, FTSE 250 stalwart WH Smith (LSE:SMWH) could be worth exploring.

Travelling upwards

The first factor that makes WH Smith special is its successful diversified business model. The company has stores in a variety of areas that include high streets, travel locations, and online channels. This provides resilience and multiple avenues for growth.

The firm recently reported a 28% jump in annual revenues. This was led by a 42% surge in its high-growth global travel division. That’s because the retailer’s travel stores have benefited tremendously from the ongoing recovery in airport passenger volumes. This shows that despite its wavering high street presence, WH Smith has the potential to stage a comeback akin to the likes of Marks and Spencer.

Looking ahead, WH Smith plans to open over 80 new stores globally in the coming year. The board has made its intentions clear that it wants to capitalise on the robust travel rebound. This is a smart strategy as passenger traffic continues to recover to its pre-pandemic levels. Provided this momentum can be sustained, WH Smith could potentially achieve 20%-30% annual earnings growth in the years to come.

This level of rapid expansion and increased profitability could serve as a powerful catalyst to send its share price soaring. After all, analysts are pricing in an annual growth rate of approximately 28%.

Expensive shopping spree?

The consensus price target currently indicates that the shares could rise by as much as 65% over the next year. The average price target of £19.10 implies the market has yet to fully account for WH Smith’s growth.

So, if profits wind up exceeding expectations as global travel recovers, this stock’s valuation multiples could be justified as it currently trades at a relatively hefty price-to-earnings (P/E) ratio of 27.1. Nonetheless, it could be on course to do just this. The group’s premium positioning gives it a solid strategic advantage to drive sustained outperformance.

Headwinds to consider

That said, risks still exist that could stop the rise of this potentially explosive share. First is the intensifying competition in the travel retail space, which cannot be ruled out. But perhaps most notably, deteriorating consumer spending could affect its top and bottom lines if the UK economy takes a turn for the worse. This could end up becoming a double whammy as it could affect travel volumes through the airport and train/bus stations, resulting in lower volumes as well.

While challenges remain, the firm seems well prepared to weather storms relative to retail peers. Therefore, for investors seeking a special under-the-radar stock with visible catalysts to potentially generate explosive returns, I think WH Smith checks many of the right boxes.

Forecasted growth of 65% over the next year isn’t monumental. But when compared to the average return of the FTSE 100, which yields less than 10% (excluding dividends), this figure is rather considerable. If I invested £20,000 today, a 65% gain would generate a return of £13,000 in a year! On that basis, I’m eyeing WH Smith shares for my next purchase.

The post Is this special FTSE 250 stock primed for explosive growth to make me rich? appeared first on The Motley Fool UK.

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John Choong has positions in Marks And Spencer Group Plc. 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.

Finding reliable high-yield stocks is the dream of many income investors. One such company that offers an incredibly generous dividend is Legal & General (LSE:LGEN). With its shares currently yielding 8.9% and having room to run, the insurer could present a gateway to generating a lifetime of second income.

Sky-high dividend yield

The first attribute that jumps out about Legal & General is its whopping forward dividend yield of 8.9%. This yield dwarfs the FTSE 100 average of under 4% by a massive margin. Immediately, this puts the shares on the radar of income-focused investors such as myself.

Legal & General has also demonstrated a strong commitment to dividend growth. The company has raised its payouts. After all, it has had a 4.2% compound annual growth rate over the past four years. Plus, management has even promised to maintain a target 5% dividend hike until 2024. As such, for investors prioritising passive income today, this degree of existing yield and growth is very hard to ignore.

Robust prospects

Aside from its exceptionally high yield, Legal & General’s prospects for continued dividend growth over the long run also appear promising. The firm stands to benefit considerably over the coming decade as pension deficits in the UK narrow and demand for annuity products continues to increase substantially.

In fact, less than a fifth of UK-defined benefit pension liabilities are transitioned to insurers like Legal & General to date. This means that the firm has an enormous amount of room to grow its market share in this lucrative industry.

As profits rise from writing significantly more annuity policies, Legal & General should have the financial firepower to keep steadily increasing its generous dividend yield in the years to come too.

What’s more, the group continues to invest in other potential growth engines. These include infrastructure projects and housing developments. These could provide additional fuel for future dividend hikes.

Long-term income

Profits are expected to fall by as much as 40% in 2023. However, this has come as a bit of a blessing to the shares’ dividend yield. This is because share prices and dividend yields are inversely correlated. The 14% drop in Legal & General shares over the past year has resulted in a stellar 8.9% dividend yield.

And despite the fall in profits, Legal & General shares are still projected to increase by as much as 27%, according to the latest analysts’ consensus. This shouldn’t come as a surprise, however. The stock currently trades at a relatively attractive forward earnings multiple of just 10.6 times after all. This is slightly lower than the insurance sector’s average of 12.6 times.

If Legal & General’s valuation expands closer in line with industry peers over the coming years while dividends continue marching higher, total returns for investors could be even greater than 27%. This provides some solid capital appreciation potential that would complement the already-generous 8.9% passive income stream.

That said, potential investors should still be wary of risks. Investing in this insurance giant could be a dangerous value trap, especially if the economy deteriorates. This could result in lower premiums from customers and lower profits, potentially resulting in a lower dividend as well. But given Legal & General’s compelling qualities and its high dividend yield, which is 2.0 times covered by earnings, I still see it as a reasonable risk to help me generate a lifetime of lucrative passive income.

The post Is this high-yield income stock the gateway to generating a lifetime of passive income? appeared first on The Motley Fool UK.

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John Choong 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.

Penny stocks can provide tremendous returns for investors, but they also carry huge risks. And one small-cap stock I would steer clear of right now is RC365 (LSE:RCGH). Despite skyrocketing earlier this year, the share price looks poised to plunge.

Overvalued with no fundamentals

The RC365 share price is up 110% this year. This has led many investors to believe it has the potential as an artificial intelligence penny stock to rival Nvidia‘s monumental gains. However, RC365 is actually just a payments company. It actually has little real exposure to artificial intelligence (AI). This is why certain investors have labelled it a meme stock.

With price-to-sales and price-to-book ratios of around 70 and 30, respectively, RC365 shares are fundamentally overvalued. This is especially the case when the company is unprofitable with less than £2m in revenue to show for it. For a fledgling business bleeding cash, these valuation multiples make absolutely no sense fundamentally.

Opaque financials

Aside from that, the firm provides little transparency into its financials beyond basic top-line figures. The lack of details on segment performance, costs, cash flow, and outlook makes it nearly impossible to accurately value the stock.

This opacity enables speculative hype — rather than fundamentals — to drive the stock price. As such, it’s a recipe for volatility and potential disaster when reality sets in. This is something most novice investors would have experienced during the 2020/21 bull market. Numerous SPACs and penny stocks went public with lofty valuations that were based purely on hype, only for them to lose most of their value in the months and years that followed.

For investors, the inability to accurately value this stock due to the lack of financial details is a bright red flag. It results in hype and hearsay to fill the information vacuum as the share price disconnects further from any reasonable valuation, as has been the case in the year to date.

I’d steer clear

While the RC365 share price could keep rising in the short term, it seems like any gains are going to be likely driven by hype rather than financial performance.

Huge insider ownership is another red flag for me. After all, CEO Chi Kit Law holds nearly 70% of the shares. This concentration poses major risks, as the share price could plummet rapidly if he starts selling, especially considering the rise of the stock this year.

Moreover, it indicates that very limited floats and liquidity exist in the market for other investors. Hence, any change in insider sentiment could have an outsized impact on the stock volatility.

Of course, the company itself could go on to do great things, but I’d only invest once I started to see that happening and at a more sensible share price.

But for investors who are seeking exposure to AI, higher-quality, larger-cap tech stocks are much safer investments. I see better underlying investment cases in other stocks such as Nvidia and TSMC which could grant me similar returns in the medium-to-long term.

The post 1 penny stock I’d avoid like the plague right now appeared first on The Motley Fool UK.

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John Choong 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.

If I had £20,000 to invest for passive income today, I’d split it across three high-yielding dividend shares. These would include Taylor Wimpey (LSE:TW), Lloyds (LSE:LLOY), and Legal & General (LSE:LGEN). And here’s how these picks could generate over £1,500 in annual dividend income for me.

1. Taylor Wimpey

Taylor Wimpey’s industry-leading 8.1% dividend yield makes it an extremely attractive stock to own. As such, I’d invest £7,000 in Taylor Wimpey shares to generate an annual dividend income of roughly £567 based on the current payout. That said, this could change. After all, headwinds for the housing sector due to higher mortgage rates and inflation could affect near-term profits and dividends.

Nonetheless, the housebuilder focuses on selling homes to more affluent buyers who are less worried about higher mortgage rates. The board has also vowed to pay out at least £250m annually, or 7.5% of its net asset value, in dividends to shareholders which should provide some form of security.

Aside from that, the stock’s valuation also looks compelling. Taylor Wimpey shares trade at just 7.5 times earnings, below its five-year average of 10. But what’s most promising is the eventual recovery of the housing market. This could see its earnings and dividends rise admirably.

2. Lloyds

Lloyds shares offer a very stable dividend with a current yield of 5.9%. Therefore, I’d invest £7,000 in the stock to generate around £413 in annual dividend income based on today’s payout.

While there’s economic uncertainty in the near term, the lender actually recently upgraded its guidance for 2023. More importantly, the bank boasts robust capital levels, and its dividend is covered nearly twice by its earnings, making payouts sustainable.

With the shares still trading meaningfully under 50p, the valuation of Lloyds shares looks attractive. That’s because they’re trading at low levels relative to earnings and book value. Plus, Lloyds’ cost-cutting initiatives bode well for future dividend growth.

Having said that, investors alike should also be wary that the Lloyds share price could decline in value and trigger a reduction in dividends. This would especially be the case if the UK enters a recession.

3. Legal & General

The same can be said for Legal & General, as a recession could see fewer insurance premiums. Consequently, its shares have been hit recently. Nevertheless, they still offer a very attractive 8.8% dividend yield. Therefore, I’d invest £6,000 in them to produce roughly £528 per year in dividends based on the current payout.

L&G has a great track record of steadily increasing its dividends over the past decade. Moreover, the insurer generates strong capital and stands to benefit over the long term as pension deficits in the UK narrow and more companies shift from defined benefit to annuity policies. This trend provides a long runway for growth in both earnings and dividends.

Trading at a cheap valuation of 6.5 times earnings, the stock’s valuation looks very attractive for the future income potential. In fact, its management team is known for being rather shareholder-friendly based on its commitment to growing dividends.

The post I’d put £20,000 in these 3 dividend shares to target £1,500 in annual passive income appeared first on The Motley Fool UK.

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John Choong has positions in Lloyds Banking Group Plc and Taylor Wimpey Plc. The Motley Fool UK has recommended Lloyds Banking Group Plc. 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.