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Why this small-cap dividend growth stock is storming ahead of the FTSE 100

Today I want to look at two companies operating in the same sector. One of these has beaten the FTSE 100 by 63% over the last year. The other has lagged the FTSE by 5%.

In this piece I’m going to discuss why these companies are performing so differently, and which one I’d rather buy.

Too cheap to ignore?

Car dealers look cheap at the moment and Lookers (LSE: LOOK) is no exception. The company confirmed this morning that it’s on track to hit consensus profit forecasts for the full year. If that’s correct, then the shares currently trade on just 7.8 times forecast earnings and offer a yield of 3.8%.

Why so cheap? One reason is that profits appear to be falling. Despite turnover rising by 5% to £2.58bn, the group’s adjusted pre-tax profit fell by 14% to £43.1m during the six months to 30 June.

UK new car registrations have fallen by 5.5% so far this year, compared to the same period last year. But Lookers reported growth in used car sales and aftersales, and the group’s gross profit for the period rose by 2.5% to £270.5m.

The main reason for the fall in profit was a big increase in administrative costs, which rose by 26% to £80.4m during the first half. The company says this was due to increases in salary, pension, rent and utility costs.

Interest costs for stock financing also rose and I suspect interest rates for car buyers will soon follow. This could slow new car sales even more.

I’m still waiting

Lookers has a decent balance sheet, helped by about £340m worth of property, plant and equipment.

But adjusted earnings are expected to fall by 7% to 13.5p per share this year. And after years of record sales, I fear the downturn in the new car market might only just be getting started. I’m avoiding new car dealers for now.

One car dealer I do own

There is one car business I am bullish about. Used car supermarket Motorpoint Group (LSE: MOTR) is the largest used car retailer in the UK.

I’m a shareholder of this FTSE 250 business, which only sells cars that are under three years old and have less than 25,000 miles on the clock.

By selling from 12 large outdoor sites, costs are relatively low and returns can be high. Although the group’s operating margin last year was just 2.1%, Motorpoint generated a return on capital employed of 76%. So for every £100 of capital invested in the business, the firm generated £76 of operating profit. That’s outstandingly good.

What could go wrong?

Customers seem to like this business. An impressive 26.2% of sales were to repeat customers last year, and the company scores highly on internet review sites.

The main risk I can see is that the company will be caught out by a combination of falling used car values and a slump in demand. This might be made worse by rising interest rates.

In fairness, there’s no sign of any problem yet. Adjusted earnings per share rose by 31% to 16.7p per share last year. Analysts expect this figure to rise by 14.4% to 19.1p during the current year, putting the stock on a forecast P/E of 11.9 with a prospective yield of 3.1%.

I believe Motorpoint could continue to drive ahead of the FTSE 100 and remain happy to hold.

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Roland Head owns shares of Motorpoint. 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.