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Why I’d ignore this stock yielding 6% and what I’d buy instead

The Marshall Motor Holdings (LSE: MMH) share price has slipped back around 23% over the past four years, even though the dividend has been rising. However, a glance at the chart shows the stock has been volatile but moving broadly sideways.

The firm sells new and used cars and provides an aftersales service. It’s a big enterprise with 106 franchises covering 23 brands and operating from 84 locations across 27 English counties. On top of that, the company runs five trade parts specialists, three used car centres, five standalone body shops and one pre-delivery inspection centre.

A tough line of business

But I reckon it’s a tough line of business to be in and highly cyclical. Indeed, many firms are making noises about gathering storm clouds in the global macro-economic environment right now. If we get a half-decent economic slump it could torpedo profits at Marshall Motor Holdings, in my view – what then for the share price? I think it would crash.

Today’s half-year results report revealed to us that pre-tax profits slipped by 9% compared to the equivalent period last year. But like-for-like revenue edged up 0.9% and underlying earnings per share ‘only’ declined by 6.8%. Despite the poorer trading than this time last year, the directors slapped almost 33% on the interim dividend because of a revised dividend policy.

Such progress with the dividend is bound to attract contrarian-minded income-hunting investors. But I think that kind of strategy is a dangerous game to play with an out-and-out cyclical stock such as this one. If profits evaporate, I think recent advances in the dividend will likely be reversed quickly.

The narrative in today’s report mentions “challenging” market conditions several times, and it’s hard for me to imagine that situation changing much any time soon. In fairness, the firm has decent-looking net asset backing of around 257p per share, and around 60% of that comprises freehold property. The share price of 140p or so compares well to that figure. Nevertheless, the share is not for me, despite the high forward-looking dividend yield running near 6%.

How I’d play stock market weakness

There is a place in my portfolio at times for cyclical stocks. But I would never try to use a share like this for a dividend-led strategy. Instead, I’d try to catch the up-leg in a cyclical move. But to do that, the stock must be on the floor after putting in an obvious low point in its profit record. It’s not clear to me that Marshall Motor Holdings has reached the bottom of its profit cycle yet. 

Instead, I’d rather play weakness in the general stock market by topping up my holdings in passive, low-cost index tracker funds such as one following the fortunes of the FTSE 100 index. Because my investment would be spread across many underlying companies, I’d have some protection against having too much invested in any one cyclical share that might crash so hard in a cyclical low that it never fully recovers afterwards. And the FTSE 100 has a good record of recovering from its lows.

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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.