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2 reasons to stay away from Pearson plc

Back in November I advised investors to steer clear of publishing giant Pearson (LSE: PSON) as I sensed the thinly covered dividend was under threat if earnings didn’t improve. But was I right to advise investors to look elsewhere for more secure income, or have I been left with egg on my face?

Lucky escape

It seems as though I’m off the hook. Further bad tidings were yet to come for Pearson in the form of a profit warning in January which sent the shares crashing 29% to 573p in a single day. Ouch! These were levels not seen since 2008 when Prime Minister Gordon Brown was busy tackling the financial crisis. So a lucky escape for those of you who shared my concerns and ignored the seemingly attractive dividend.

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Full-year results were to follow in February, with the revelation of a massive £2.56bn pre-tax loss for 2016, compared to a £433m profit the previous year, with sales falling 8% to £4.55bn in underlying terms. This was blamed on expected declines in US and UK student assessment and US school courseware, and a much worse than expected decline in North American higher education courseware.

Dividend cut?

Pearson’s shareholders have been suffering for quite some time, with the share price now 58% below its 2015 peak of 1,508p. But until now the generous dividend provided some solace. Despite the poor results, management decided to maintain the full-year dividend at 52p per share, saying they will rebase it from 2017 onwards. Folks, that’s a polite way of saying it will most likely be cut. So that’s one reason why I think investors should continue to stay away.

Pearson’s CEO John Fallon has vowed to accelerate the company’s transformation programme, simplify its portfolio, control costs, and focus on investment in its biggest growth opportunities in education. But earnings have been in decline since 2011, and despite the ongoing digital transformation programme, this trend is set to continue with analysts expecting profits to shrink by a further 16% during the course of 2017. That’s the second reason why I continue to be cautious.

The share price has staged a reasonable recovery since the January sell-off, but is still 25% lower than a year ago. However, lower earnings forecasts mean that a P/E ratio of 13 is nowhere near cheap enough to tempt me to buy Pearson as a long-term recovery play.

Growth Acceleration Plan

If you’re still looking to gain exposure to the media & publishing sector then perhaps a better alternative to consider would be Informa (LSE: INF). The London-based international publishing and events group is continuing to make good progress with its ‘2014-2017 Growth Acceleration Plan’. Its improved operating performance is supported by strong returns from acquisitions and favourable currency trends.

Informa has a good track record of steady earnings growth and I remain bullish on the group’s long-term prospects with an increasing proportion of recurring and predicable revenues coming from subscriptions and exhibitions. The valuation is also reasonable with the P/E rating dropping to 13 next year.

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Bilaal Mohamed has no position in any 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.