A stock’s dividend yield tells you a lot about what the market expects to happen to future earnings. When a share yields 14%, the market is usually telling you that, at the very least, a dividend cut is likely.
Of course, there are exceptions to every rule. Sometimes the company concerned is being mispriced by the market. Buying at these levels can deliver big profits.
Here’s one I bought earlier
My first company today is online spread-betting and CFD firm Plus500 (LSE: PLUS), in which I own shares. Profits rocketed at this online financial trading firm during last year’s cryptocurrency boom, as traders piled into this ‘hot’ market.
With crypto markets calming down, and new regulations limiting the amount of leverage available to amateur traders, there was some risk that profits would fall this year. However, this hasn’t happened so far, as my Foolish colleague Peter Stephens explains.
What can shareholders expect?
Last year, Plus500 reported earnings of $1.75 per share. Analysts’ forecasts for 2018 are for a figure of $2.92 per share, an increase of 66%.
The company’s policy is to pay out at least 60% of earnings as dividends, or share buybacks. But this figure is sometimes higher. Last year, dividends totalled $1.6867 per share, or about 96% of full-year profits.
My sums show that if the firm pays out 60% of earnings this year, the dividend yield at current levels would be about 10%. City analysts expect a more generous payout and have forecast a figure of $2.48 per share — equivalent to a yield of 14.2%.
What could go wrong?
One risk is that earnings are expected to fall by about 21% in 2019. After years of strong growth, Plus500’s fortunes may have peaked.
Many investors also question why this business is so much more profitable than UK-based rivals, such as IG Group. One possibility is that the firm doesn’t hedge its customers’ open positions in the same way as its FTSE 250 rival.
Plus500 shares trade on a forecast P/E of just 5.8, suggesting the market remains sceptical about this Israel-based company. As a shareholder, I view the shares as a risky, but potentially rewarding, buy.
A safer 7% yield?
Plus500 isn’t the only high-yielding FTSE 250 financial stock. One alternative choice is motor insurer Hastings Group (LSE: HSTG).
Hastings’ share price is down by 11% at the time of writing, after the company warned that tough competition and rising claims would hit profit margins this year.
The firm said that claims losses are now expected to be between 75% and 79% of premiums, up from 73.8% during the first half of this year.
Buy on weakness?
Today’s figures show that the group’s market share remained stable during the third quarter. Live customer insurance policies totalled 2.7m, giving the group a 7.5% share of the private car insurance market.
I don’t see today’s news as a major concern. Profit margins may fall slightly, but the group’s valuation seems to reflect this risk, with a forecast P/E of 8.7, and a prospective yield of 7%.
In my view, Hastings could be a decent income buy at current levels.
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Roland Head owns shares of IG Group Holdings and Plus500. 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.