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Forget about 1.5% from a cash ISA. I’d pick up 7% from these FTSE 250 dividend stocks

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If you want to use your savings to build a second income, a cash ISA is likely to be a big disappointment. Best-buy interest rates are hovering around 1.5% at the time of writing.

Personally, I’m not prepared to tie up my money for such poor returns. I prefer to invest most of my spare cash in dividend stocks.

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Although the risks are greater than with cash savings, the potential returns are also higher. For investors with a long-term view, I think dividend stocks are still a great choice.

A long-term winner?

Shares in IG Group Holdings (LSE: IGG) were down by nearly 10% at the time of writing. The drop came after the company said new EU regulations had caused group revenue to fall by 6% to £251m during the six months to 30 November. Operating profit fell by 18% to £112.5m.

EU changes limit the amount of leverage available to retail customers trading contracts for difference (CFD). This has forced many to scale back their trading or quit altogether. Revenue from affected countries fell by 17% during the half year.

However, the news wasn’t all bad. During the second quarter, IG generated 69% of its EU revenue from professional clients, who are exempt from the rules. Cash generation remains strong with 89% — £100m — of six-month operating profit converted into surplus cash. The group also remains highly profitable, with an operating margin of 44%.

A bargain buy?

IG has a number of new services due to launch this year that should help to diversify its profits. IG’s new chief executive, June Felix, confirmed on Tuesday that she expects profits to return to growth in 2019/20.

In the meantime, the company has reiterated plans to maintain the dividend at 43.2p per share until it can be increased once more. After today’s share price fall, this payout provides a 7.4% yield.

A dividend cut is still possible, but in 13 years as a listed company, IG has never yet cut its payout. Today’s figures suggest to me that the payout looks safe unless trading worsens. I think the shares look good value at under 600p.

An under-the-radar income stock

One FTSE 250 name you probably haven’t heard is Sabre Insurance Group (LSE: SBRE). This motor insurance firm specialises in drivers who attract higher premiums. It floated on the London market in December 2017.

So far the shares have gone nowhere, but Sabre’s results to date suggest to me that it could be an attractive opportunity for income seekers.

Super profits

The company’s specialist focus appears to support very high profit margins. During the first nine months of 2018, Sabre generated a combined ratio below the group’s “mid-70%s target”. The combined ratio compares a company’s claims costs and operating expenses with its income from insurance premiums.

A combined ratio of less than 100% means that an insurer’s underwriting is profitable. A figure of between 70% and 75% is very good indeed. For shareholders, this should mean plenty of surplus cash to fund generous dividends.

Analysts certainly expect the group to perform well. They’re forecasting a payout of 19.1p per share for 2018, giving the stock a dividend yield of 7.1%. I believe Sabre could be a buy for income.

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Roland Head owns shares of IG Group Holdings. 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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