At the time of writing, shares in financial services group IG (LSE: IGG) offer a highly attractive dividend yield of 7.8%.
However, while this distribution might look attractive at first glance, I’m not a buyer of the shares because it seems to me as if the group is facing a revenue cliff edge.
The last time I covered IG, I concluded that the stock might be worth buying as an income investment because it can use its size to consolidate the spread betting and contracts for difference markets (CFD) following the introduction of some strict regulations for the sector last year.
I still think IG will come out on top over the long term, but the company’s latest trading update seems to suggest the trading environment for the group is going to become a lot worse before it gets better.
Indeed, today IG reported that during the three months to February, the second full trading quarter following the introduction of the new rules on CFD trading, revenues slumped 29% to £108m.
This is much worse than both the company and City analysts were expecting. Just six months ago, IG’s management told investors they were expecting a 10% decline in revenues. In the first quarter after the rules were introduced, revenues slumped 23%.
Trading in these first few quarters seems to suggest IG’s profits for 2019 will decline faster than expected. Analysts had pencilled in a decline in earnings per share of 23% for fiscal 2019 off the back of a 15% revenue decline. With initial figures showing revenue is declining twice as fast, I do not think it is unreasonable to suggest that IG’s earnings per share could slump by as much as 30% and possibly more this financial year, which would put the company’s dividend in danger.
A 30% reduction in earnings per share indicates dividend cover will fall to just one this year, and that is assuming profits don’t fall any further than 30%.
If earnings per share decline 40%, the payout will not be covered. And even though the company’s strong balance sheet provides some cushion (at the end of fiscal 2018 it reported £352m of net cash) with earnings set to slump over the next two years, I think IG’s dividend yield is living on borrowed time.
With that being the case, I would sell the shares and buy the FTSE 100 instead.
A better buy
The reason why I think the FTSE 100 is a better buy than the financial services group is that there is a lot of uncertainty around at the moment, which makes it difficult to pick stocks.
By investing in the FTSE 100, you do not have to worry about picking individual firms, and whatever happens to the UK at the end of March, I think the index will still provide investors with a steady return as more than 70% of its profits come from outside the country.
On top of this, there’s a 4.6% dividend yield on offer, which, because it is an average of all the companies in the index, looks much safer than the distribution offered by IG.
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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.