Today I am assessing the dividend potential of one of the highest-yielding stocks in the FTSE 250: Playtech (LSE: PTEC).
Fat profit margins
Playtech is an interesting enterprise. The company supplies technology for the gambling industry, which as it turns out, is a very lucrative business.
Over the past five years, it has reported an average operating profit margin of 43% and return on capital employed — a measure of profit for every £1 invested in the business — of approximately 15%, nearly three times higher than the current market average. And because the development of software does not generally require a large amount of capital spending, its fat profit margins give it plenty of cash to return to investors.
According to my calculations, over the past five years, the company has distributed £666m to investors via dividends, approximately 44% of its current market capitalisation.
I see no reason why this trend cannot continue for the foreseeable future. City analysts believe Playtech has the potential to produce earnings per share of 52p for 2018, and distribute 31.4p of this to investors, giving a potential dividend yield 6.8%. The payout is expected to grow modestly to next year to 35p thanks to a 14% uptick in earnings. If the company hits this target, investors are in line for a potential dividend yield of 7.4%.
Not only do the shares support a market-beating dividend yield, the stock is also trading at a relatively undemanding forward P/E of 8, compared to the IT services sector average of 19. Put simply, if you are looking for an undervalued business with a market-beating dividend yield to add to your ISA, I reckon Playtech could be the perfect pick.
On the other hand, Sportech (LSE: SPO), Playtech’s smaller peer, does not appear to offer the same level of value.
The last time I covered this market minnow, I speculated that recent developments in the US sports betting market could give the company “tremendous scope to grow over the next decade.“
Unfortunately, it seems that management is struggling to capitalise on the opportunities available in the US. A trading update from the company today informed investors that, “certain expected sales contracts are unlikely to be secured in 2018,” so adjusted earnings before interest tax depreciation and amortisation (EBITDA) for the year are likely to come in as much as 10% below current market expectations.
Even though this lower target will still represent year-on-year adjusted EBITDA growth of as much as 20%, it is a disappointment for shareholders who had been expecting much more from the company.
Before today’s announcement, shares in Sportech were changing hands for more than 20 times forward earnings, reflecting investor optimism in the business. Now that the outlook has deteriorated, I’m not convinced that it is worth paying a premium for the stock. Playtech, with its already established business and attractive dividend schedule, is a much better buy in my opinion.
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Rupert Hargreaves owns no share 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.