One 5%+ dividend stock I’d buy today, and one I’d avoid

A focus on quality could pay off for investors, says Roland Head.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

I’ve often found that hunting through the market for dividend stocks with yields of around 5% can turn up some real bargains. In today’s article I’m going to look at one 5% yielder I’d buy and one I’m happy to avoid.

A mixed picture

Shares of FTSE 250 omnichannel fashion retailer N Brown Group (LSE: BWNG) fell by 14% in the opening hour of trading on Tuesday, after the group issued a trading statement.

Given this reaction, you might expect news of a profit warning. But that wasn’t the case. Full-year profit guidance was unchanged and the group reported revenue growth of 3.2% for the 18 weeks to 6 January.

Should you invest £1,000 in Legal & General right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Legal & General made the list?

See the 6 stocks

So what’s gone wrong? It seems that achieving sales growth has required heavy promotional spending. As a result, gross profit margins on products are now expected to fall by between 2.25% and 2.5% this year, compared to previous guidance for a drop of 0.7%-1.2%.

However, this fall in profit from retail should be offset by higher finance profits. Like a number of fashion retailers, N Brown makes a lot of its profit from customer credit.

An increase in the size and quality of the group’s loan book means that gross margin from financial services is now expected to be around 5% higher this year, compared to previous guidance for an increase of 1%-2%.

Cheap enough to buy?

I estimate that financial services are likely to provide around one third of N Brown’s total profits this year. This should help to support profit and dividend forecasts for the current year.

However, I’m concerned that profit margins on clothing may continue to weaken. I’m also unhappy at the risk that a slowdown in credit sales would result in a double hit to profits, as customers would buy less and pay less in interest charges.

Although the stock’s P/E rating of 11 and forecast yield of 5.9% might be said to look cheap, I think there are better options elsewhere in the retail sector.

One stock I’d buy

One potential example is cycle and automotive retailer Halfords (LSE: HFD). Like-for-like sales at the group rose by 2.7% during the third quarter, and are up by 1.9% for the year to date.

Halfords attracts me for several reasons. The group’s focus on cycling, car accessories and car servicing (Autocentres) has allowed it to navigate a changing market without serious problems. A strong balance sheet has also helped to maintain stable free cash flow and to support the dividend.

Although profit margins have fallen over the last five years, the group’s return on capital employed is still attractive at around 13.6%. This compares well to N Brown’s 2017 ROCE of 7.7%.

Strong returns help to generate plenty of cash, and Halfords scores well here too. The group’s shares trade on a trailing price/free cash flow ratio of 15, compared to a figure of 27 for N Brown.

Halfords cash generation underpins its dividend, which has been consistently covered by surplus cash in recent years. The group’s shares currently trade on a forecast P/E of 12, with a prospective yield of 5.1%. In my view they provide a much better quality opportunity to make money than those of N Brown.

Should you invest £1,000 in Legal & General right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets.

And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Legal & General made the list?

See the 6 stocks

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head has no position in any of the shares 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.

Pound coins for sale — 51 pence?

This seems ridiculous, but we almost never see shares looking this cheap. Yet this recent ‘Best Buy Now’ has a price/book ratio of 0.51. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 51p they invest!

Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.

What’s more, it currently boasts a stellar dividend yield of around 8.5%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?

See the full investment case

More on Investing Articles

Young Asian woman with head in hands at her desk
Investing Articles

As the S&P 500 struggles to recover, here’s what Warren Buffett’s doing

The S&P 500 is fighting to regain its February highs amid ongoing trade tariff uncertainty. Our writer looks to the…

Read more »

Investing Articles

When will Lloyds shares hit £1?

Lloyds shares have surged over the past 12 months, but where will they go next? Dr James Fox thinks there’s…

Read more »

Middle-aged white man wearing glasses, staring into space over the top of his laptop in a coffee shop
Investing Articles

Stock-market crash: the meltdown of the Magnificent 7

Just before Christmas, these Magnificent Seven stocks were riding high. But after the worst quarter for US stocks since autumn…

Read more »

Investing Articles

Wow! IAG shares are undervalued by 47%, according to analysts

IAG shares have surged over the past 18 months, but analysts are pointing to more growth. Dr James Fox takes…

Read more »

Investing Articles

2 cheap FTSE 100 and FTSE 250 shares to consider for an ISA before 5 April!

These FTSE 100 and FTSE 250 shares are on sale today! Here's why long-term Stocks and Shares ISA investors should…

Read more »

Investing Articles

How I’m building a new second income for 2035

Millions of us invest for a second income. Here are the steps Dr James Fox is taking in order to…

Read more »

Investing Articles

At a 52-week low but forecast to rise 73%! Is this growth share the FTSE’s top recovery play? 

This FTSE 100 growth share has taken an absolute beating over the past two years but Harvey Jones says the…

Read more »

Investing Articles

This FTSE 250 share offers a juicy 9.8% yield. Will it last?

This well-known FTSE 250 share has a percentage dividend yield approaching double digits. Should Christopher Ruane add the income share…

Read more »