Do these overlooked income stocks offer unbeatable value?

The Motley Fool

In rising markets, it often pays to look beyond the obvious choices when hunting for potential value and income stocks.


Two companies that updated the market this morning fall into this category. Car dealer Pendragon (LSE: PDG) and listed private equity firm 3i Group (LSE: III) aren't popular choices among private investors. Both have performed well since the financial crisis but which is the strongest buy now?

Pendragon's normalised earnings per share have risen by an average of 17% each year since 2010. 3i's earnings per share are up an average of 34% each year since 2011. Dividends have also risen strongly at both firms.

Invest like a PE guru

Stock market investors wanting exposure to private equity have very few choices. FTSE 100-listed 3i Group is one of a handful of listed private equity firms on the London market. The group said this morning that it will sell its debt management business -- which manages corporate debt funds -- for £222m to Investcorp.

3i expects to book a £36m profit on the sale of this unit, which it purchased in 2011. Chief executive Simon Burrows said that while the debt management business has produced strong cash flows, "it fits less well with the 3i of today." The business will now be focused on just two areas, private equity and infrastructure investment.

The proceeds of today's deal will be invested in the business but 3i shares have remained broadly flat today, suggesting that the market thinks the near-term effect on profits will be neutral.

The shares have risen by 228% over the last five years as a restructuring led by Mr Burrows has delivered strong results. Earnings growth will always be lumpy due to the long-term nature of 3i's investments. But the pace of growth does appear to be slowing. Earnings per share are expected to rise by just 6% during the current year and may fall by 24% next year, based on broker forecasts.

Although 3i's forecast P/E of 7.3 is tempting, I think it makes more sense to value an asset-based business like this in terms of book value and yield. On these measures, 3i looks fully priced. The shares have a price/book ratio of 1.4 and offer a forecast yield of just 2.8%.

I'd continue to hold, but would probably wait for a better opportunity to buy more.

Motoring ahead?

Shares in car dealership groups have sold off hard since June's Brexit vote, despite trading remaining robust.

Today's quarterly statement from Pendragon is a good example. Like-for-like revenue rose by 4.7% during the three months to 30 September, while underlying pre-tax profit rose by 6.3%.

New car registrations only rose by 1.4%, but Pendragon used today's statement to remind investors that after-sales is the largest contributor to profits. Like-for-like gross profit from after-sales rose by 3.2% during the period. The number of cars under three years old has been rising. Such cars are usually under warranty and maintained at main dealers, such as those run by Pendragon.

Pendragon is the largest listed firm in the UK automotive retail sector. It also offers the highest dividend yield. If you believe the UK economic outlook will remain fairly stable, then Pendragon's forecast P/E of 7 and 5.1% forecast yield may be worth considering.

A better retail choice?

If you're considering an investment in Pendragon, then you may be interested to know that our experts believe there are better opportunities elsewhere in the UK retail sector.

They recently selected another mid-cap retailer for their latest report, A Top Growth Share From The Motley Fool.

The company in question is growing fast and is also expanding overseas. Indeed, our analysts believe this business could triple in value over the next few years. This exclusive new report is free and without obligation.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended Pendragon. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.