Despite continuing to achieve record levels of profitability, the share price of sub-prime auto lender S&U (LSE: SUS) has fallen 15% over the past year as market commentators have turned negative on the medium-term outlook for its sector. But with its shares now trading at just 9.6 times forward earnings with analysts expecting a 5.3% dividend yield for the year, should investors pile in?
Well, so far the problems that some columnists have found in the sector, such as loan repayments eating up an outsized portion of borrowers' incomes, haven't found their way through to S&U's books. In the company's latest trading update covering 18 May to 31 July, it increased the volume of new loans by 20% year-on-year (y/y). And it doesn't appear that its customers are finding the loans burdensome as monthly collections rose 27% y/y and hit a record £10m in June and July.
Strong collections performance and the increasing benefits of scale certainly appear to be setting the stage for an 18th consecutive year of record pre-tax profits. Indeed, investors responded to this morning's trading update by sending the company's share price up over 2%, suggesting some are finding analysts' consensus forecast for a 19% increase in earnings this year to be a bit low.
Now, this doesn't mean problems in the sector won't eventually affect the company. Would-be investors should closely follow the company's impairment rate, which acts as a decent bellwether for the quality of loans S&U is advancing. Last year the impairment rate did rise to slightly over 20% but is still within respectable limits. Furthermore, management blamed increased competition to attract higher-quality customers for the increase in impairments and this argument makes sense as we saw the much larger sub-prime lender Provident Financial attempt to push its way into the sector.
Investing in S&U isn't without its risks, but the company has a stellar history of shareholder returns, its loan book still looks pretty healthy and even if the economy heads into reverse, the fact that its loans are secured should provide some peace of mind. Given these positives, a high dividend yield, operating margins of 41% last year and an attractive valuation, S&U is certainly on my watch list.
Painting a pretty picture
Another growth share that I reckon could turn into a very nice income share over the long term is value make-up company Warpaint London (LSE: W7L). As you could probably guess by its name, the company prefers brash designs, colours and names for its products.
The company's strategy is to figure out the latest trend in make-up, quickly get the factories in China and Europe it sources from to churn out the product and then distribute it to its retail and distributor clients. In 2016, its first as a public company, the ability of its founder-led management team to successfully execute this strategy was on display. Sales rose 21.1% y/y to £27m as it began direct-to-consumer online sales and signed on 49 new clients to take its total to 319.
The beauty of its business model is that by not having to run expensive high street stores the company is very profitable with operating margins around 25%. It's still early days and the company is highly valued at 17 times earnings but I see plenty of reason to closely follow Warpaint London.
But if Warpaint London's valuation is just a bit too pricey for your taste, I recommend checking out the Motley Fool's Top Small Cap of 2017, which trades at just eight times earnings. On top of a bargain basement valuation, this company has also increased earnings by double-digits four years in a row.
To discover the secret to its success, simply follow this link for your free, no obligation copy of the report.
Ian Pierce has no position in any 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.