Investing in stocks with very high dividend yields is always tempting. Today, I want to look at a company that yields 7% and also a firm with a much lower dividend yield. I’ll explain why one of these stocks is already in my portfolio and why the other is now on my watch list.
Is a profit warning on the horizon?
Online financial trading firm IG Group Holdings (LSE: IGG) has fallen by 37% over the last six months. The company’s stock is out of favour because of new regulatory restrictions hitting revenue. In short, non-professional traders can’t use as much leverage as they could previously.
IG isn’t the only company to be hit by the changes. Rivals Plus500 and CMC Markets have both issued profit warnings recently, saying that the impact of the new rules is more serious than expected.
Investors are worried that IG might have to do the same. With a trading update due in late March, we won’t have long to wait. But in the meantime, I think IG could be worth a look for long-term investors. Here’s why.
Buy the market leader
IG has been in business for 45 years, during which time it’s become a global leader in online CFD trading and spread betting. It’s the largest such firm listed in the UK and generates more revenue from professional traders (who are exempt from the new rules) than Plus500 or CMC Markets.
It’s also a very profitable and well-funded business. Over the last five years, IG’s generated an average pre-tax profit margin of 47% and consistently maintained a net cash position.
This tells me that this business should cope easily with a period of change, during which profits might dip. The group is working to diversify and I’m sure it will find a way to return to growth.
In the meantime, the shares appear to be priced for a fairly grim future, on 11.5 times 2019 forecast earnings, with a 7.6% dividend yield. I rate IG as a buy and have bought some myself.
Compare this
Unlike IG, price comparison website Gocompare.com Group (LSE: GOCO) isn’t the biggest in its sector. But results published on Thursday suggest to me it could be an attractive investment.
Although revenue only rose by 2.3% to £152.6m last year, operating profit jumped 14.2% to £37.7m. The reason for this is the company focused on maximising profits, rather than growing at all costs.
Although the number of customer interactions fell by 16% to 27.1m, the average revenue from each rose by 10% to £5.13. That seems fine to me, but some investors appear to be spooked. The shares were down by about 6% at the time of writing.
In my view, this downbeat view is unjustified. This business generated an operating profit margin of 24.7% last year and a return on capital employed of 105%. That means that for each £100 of capital invested in the business, Gocompare generated an operating profit of £105.
Some of this cash is being invested in new technologies, such as the weflip automated utility switching service. I expect more of this kind of service, which should drive repeat income from loyal customers.
Today’s results have left the shares trading on 8.4 times 2018 earnings with a 2.5% yield. I think that’s too cheap and have added the shares to my watch list for a possible purchase.
