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Have £1,000 to invest? This 7.5% yielder is absolutely crushing the FTSE 100

If you’re in the early stages of building a stock portfolio, putting money into a FTSE 100 tracker fund is a fairly safe option. Although the value of your investment could fall in a market slump, the index usually bounces back over time.

Even if your investment is showing a loss, you’ll continue to receive the FTSE’s 4% dividend yield, giving you a useful income.

The problem, of course, is that you can never beat the market by investing in a tracker fund. To outperform the FTSE 100, you’ll also need to invest directly in stocks and shares.

Today I’m going to look at a couple of household names you might want to consider.

Crushing the FTSE

My first choice is sofa and carpet retailer SCS Group (LSE: SCS). Despite the well-known pressures on high street retailers, SCS is doing pretty well.

The group’s share price has beaten the FTSE 100 by about 26% since my colleague Rupert Hargreaves covered the stock in October last year. And shareholders have also enjoyed a dividend yield of more than 7%, nearly double the payout from the big-cap index.

Figures published yesterday show that the Sunderland-based firm’s revenue rose by 1.3% to £337.3m during the 52 weeks to 28 July. Tight control of costs meant that the group’s operating profit rose by 10.5% to £13.2m, lifting its operating margin from 3.6% to 3.9%.

Even better than it seems

A key attraction of this business is that its costs are very flexible. By outsourcing production and making furniture to order, SCS enjoys strong cash generation and flexible costs.

The group’s net cash balance rose from £40m to £48m last year, and management said that 75% of costs are variable or discretionary. In my view, this combination of flexible costs and a cash buffer should mean a very low risk of financial distress, even in a recession.

Analysts expect SCS Group’s profits to be fairly flat over the next couple of years. But the 7.5% dividend yield is well supported. I think further gains may be possible.

Can this larger rival fight back?

DFS Furniture (LSE: DFS) is about five times larger than rival SCS. But size is no guarantee of better results.

DFS was forced to issue a profit warning in July, after sales fell significantly below management expectations during the hot weather. Today, the company revealed just how badly its profits were damaged.

The group’s full-year sales fell by 2% to £747.7m during the year to 29 July, excluding acquisitions. Including acquisitions, sales were 14% higher at £870m. But even this wasn’t enough to protect the group’s underlying pre-tax profit, which fell by 23.7% to £38.3m.

A debt bomb?

DFS Furniture’s operating margin fell from 6.1% to 3.4% this year, including acquisition and restructuring costs.

Lower profitability and the £25m acquisition of Sofology caused net debt to rise by 10% to £159m. Worryingly, this now represents 2.1 times underlying cash profits (EBITDA). That’s a big increase from last year’s figure of 1.75 times, and is well above the board’s target level of 1.5 times EBITDA.

Analysts expect profits to bounce back this year, with a 30% rise in earnings per share. This bullish outlook has left the shares trading on 11 times 2019 forecast earnings, with a prospective yield of 5.3%.

Personally, I’m not so keen. I think DFS looks risky and poor value when compared to SCS.

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Roland Head 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.