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Why I’ve changed my mind about this 5% dividend yielder and what I’d buy instead

I reckon it pays to invest with a great deal of caution. But sometimes stocks can look attractive yet still harbour ‘hidden’ downside risks that outweigh their potential for gain. To me, one current example is construction and regeneration specialist Morgan Sindall (LSE: MGNS).

Today’s half-year results report is full of positives, which works with the firm’s recent trading record to make it look fantastic. And it is in many ways. The company seems like it has been managed well and is very good at what it does. Progress shows up in the dividend record because the payment has increased by around 100% over the past four years or so.

Good trading and a positive outlook

Meanwhile, the valuation makes my mouth water. The current share price around 1,140p throws up a forward-looking earnings multiple of just over seven for 2020 and the anticipated dividend yield runs a little higher than 5%. If you adjust for the firm’s pile of net cash, the valuation looks even keener.

And trading has been going well. In the first six months of the year, revenue came in broadly flat compared to the equivalent period the year before. But adjusted earnings per share shot up 15% and the net cash pile increased by 17.5%, up to £114m. We can assume the directors were pleased with the company’s performance and the outlook because they slapped 11% on the interim dividend.

Indeed, chief executive John Morgan said in the report he is “excited” by the opportunities ahead. At the end of the period, the order book stood at £4,229m, up 19% from the previous year-end. We’re talking about construction projects in sectors such as highways, rail, aviation, energy, water, nuclear, education, healthcare, defence, commercial, industrial, leisure and retail. And in the fit-out market for offices, commercial premises, education properties, and government offices. The company is also active in property services and developments for social housing and other areas.

A difficult sector

But despite the rosy picture, I’ve changed my mind about the stock. I see huge potential for slip-ups in the tendering process and during the execution of contracts. Morgan Sindall says itself that today’s good results demonstrate “the discipline of maintaining selectivity with the overall quality of projects taken on and the focus on operational delivery and risk management.”

What nags me is the frequency of past ‘train wrecks’ in the wider construction and contracting sector. I’m thinking of firms such as Carillion, which went bust. And Kier Group looked as if it was in pretty good shape when I wrote about it a couple of years ago, prior to its share-price collapse. I admit that Morgan Sindall has a stronger balance sheet than those other two firms, but I’m wary of the sector in general, so would rather invest in an index tracker fund that follows the wider stock market than in Morgan Sindall.

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Kevin Godbold has no position in any 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.