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Two cheap 5% yields that can grow by 25%

To find the market’s best income stocks, you have to look off the beaten track. Often, the search for income takes you to distant corners of the market, sectors you wouldn’t usually investigate, or even consider as they fall outside of your usual focus. However, it is often the case that the market’s best bargains are hidden in these dark corners and only by venturing out of your comfort zone will you be able to find these securities. 

One such stock is Morses Club (LSE: MCL). The consumer finance business has only been public for a little over a year but is already an established income stock. The company offers unsecured loans to customers over 20-to-78-week periods, and thanks to the scrutiny this industry has been subject to over the last few years, it has fallen out of favour with investors. 

Based on City estimates for growth, shares in the credit business currently trade at an undemanding forward P/E of 12 and support a dividend yield of a little under 5%. There’s also plenty of room for payout growth in the years ahead. 

Future dividend champion 

Morses recently gained its full FCA authorisation, so the business is one of the few in the short-term loan sector that’s fully regulated, which should help improve growth. By the end of the fiscal year to 28 February 2019, City analysts are projecting total three-year earnings per share growth of 30.3%, taking earnings per share to 13.3p. Based on current estimates, Morses is on track to pay out 6.4p per share this year, a payout that’s covered 1.7 times by earnings per share. Such a low payout ratio gives plenty of room for further payout growth. 

In fact, City analysts are expecting the payout to grow by 24% over the next three years as earnings expand and the payout ratio remains constant. If management decides to pay a larger share of profits, the payment could grow even faster. If the ratio declines to 1.5 times, Morses will yield 6.9% with a per-share dividend of 8.8p. 

Safe yield 

Safecharge International (LSE: SCH) is another hidden financial stock that looks attractive as an income investment. At the time of writing, the shares support a historic dividend yield of 4.9%, but analysts are expecting management to hike the payout by 11% this year for an estimated 14.1p or yield of 5.3%. Further growth is expected for the following year. Analysts have pencilled-in dividend growth of 5% for 2018 giving a projected yield of 5.5%. 

And I wouldn’t rule out upward revisions to these estimates. Safecharge’s earnings are rising rapidly. Earnings growth of 24% is expected this year, followed by 13% during 2018. This rapid earnings rise may encourage management to hike dividend payouts further. At the time of writing shares in Safecharge currently trade at a forward P/E of 15.5 falling to 13.8 for 2018. Considering the company’s fast earnings growth, this high valuation does not appear to be too demanding. 

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Rupert Hargreaves 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.