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Forget the cash ISA! These FTSE 250 dividend growth stocks could help you retire early

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There’s no doubt in my mind that saving cash is a poor way to make money. Looking around the market, interest rates on most savings accounts still seem to be hovering around 1%. That’s well below inflation, which is currently 2.4%.

What this means is that the real value of your cash savings is probably falling, not rising.

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I’d always recommend saving at least three months’ income in cash before investing in the stock market. But over the long term, I believe that equity investment offers a much more reliable way of building retirement wealth.

This could be a long-term success

FTSE 250 cybersecurity firm Avast (LSE: AVST) is a name that may be familiar to you from the anti-virus software on your PC. This business is bigger than you might realise, with more than 435m users globally in over 59 countries.

Avast only floated on the London stock market in May this year. So the firm doesn’t have a very long track record with UK investors. However, its financial performance so far seems promising.

During the first nine months of 2018, the group’s adjusted revenue rose by 4.7% to $613.1m. Adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) for this period rose by 8.8% to $335.6m, giving an adjusted EBITDA margin of 54.7%.

A potential cash machine

Adjusted profit figures like this are all very well, but they don’t always reflect a company’s cash generation or debt obligations.

My colleague Ian Pierce covered Avast’s half-year figures earlier this year. These showed free cash flow after interest payments of $123m, versus a reported operating profit of $109.7m.

Although the firm’s net debt of 2.8x EBITDA is above my preferred maximum of 2x, Avast’s strong cash generation gives me confidence that it should be able to reduce borrowing levels quite quickly.

With the shares trading on 13 times forecast earnings, I believe this stock could be worth considering as a long-term growth opportunity.

Woodford dumped this stock… I wouldn’t

FTSE 250 IT infrastructure group Softcat (LSE: SCT) sells IT equipment and services, building infrastructure such as networks, data centres and security solutions for customers.

The stock was previously held by top UK fund manager Neil Woodford, but as my colleague Ed Sheldon explained, Woodford sold his shares earlier this year. I’m not going to guess at his reasons for selling, but I can say that this isn’t a share I would have chosen to sell myself.

Highly profitable

Yesterday’s full-year results showed that Softcat’s revenue rose by 30% to £1,082m last year, while operating profit climbed 36% to £68m. According to the firm, 97.7% of operating profit was converted to cash — an impressive figure.

Although yesterday’s results only indicate an operating margin of 6.3%, this firm’s lack of costly factories and other major assets means it generated a return on capital employed of 67% last year. That’s exceptionally high.

Softcat’s share price has fallen by 22% from its August high of 888p, to just 690p at the time of writing. This has left the shares trading on 24 times 2019 forecast earnings, with a 2.5% dividend yield.

That’s still a little pricey for me, given that earnings growth is expected to slow to around 5% this year. But if the shares fall below 600p — lifting the dividend yield to about 3% — I would start to get seriously interested.

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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.

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