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£1,000 to invest? I’d shun this FTSE 250 faller in favour of this bargain 10% yielder

Harvey Jones
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Crashing out of the FTSE 100 is tough, but it isn’t the end of the world. These two companies have both suffered that fate lately, but may still have something to offer investors.

Dixons Carphone

Dixons Carphone (LSE: DC) dropped out of the blue-chip index in May 2017 and has been ringing up wrong numbers ever since.

The electrical and telecoms retailer, formed in 2014 by the merger of Dixons Retail and Carphone Warehouse Group, is down almost 30% over the last 12 months, and 67% over three years.

It has been hit hard by tough competition, notably from Amazon, while the weaker pound has driven up the cost of imported electrical items, making the group yet another victim of the squeezed UK retail sector.

The mobile phone market is no longer the growth monster it once was, as the likes of Apple struggle to come up with a new killer function. The biggest pull of the new iPhone 11 Pro is three cameras instead of one. Don’t all rush. Accordingly, Dixons’ Q1 mobile sales fell 10%, as more people cling to their old hardware, buy unlocked handsets, or SIM-only deals.

Dixons Carphone’s market cap has shrunk to £1.3bn but many will be tempted by its low valuation of just 8.4 times forecast earnings, and big fat juicy yield of 5.6%, covered 2.1 times. Against that, you have to weigh the group’s rising net debt and falling cash flows. As the Brexit squeeze on consumer sentiment intensifies, I suspect this stock could prove a bad call.

Direct Line Insurance Group

Direct Line Insurance Group (LSE: DLG) crashed into the FTSE 250 in September after the share price took another downward lurch following a 10.8% drop in first-half pre-tax profits to £261.3m. This is a long-term slide, with the Direct Line share price trading 20% lower than three years ago. 

The group has been hit by the Financial Conduct Authority’s regulatory probe into car and home insurance pricing, amid long-standing complaints that new customers get a much better deal than existing ones. While the FCA is not explicitly targeting Direct Line, it has been hit notably hard because it makes most of its money from these two markets, against less than 20% of profits at globally diversified rivals such as Aviva and RSA Insurance Group.

Competition for motor insurance customers is also tough, as comparison sites intensify the focus on price, to the point that Direct Line refuses to appear on them, which shuts off an awful lot of customers.

Direct Line nonetheless has a strong brand and modest debt. Two other factors count in its favour. First, the £4bn group is trading at just 10.8 times forward earnings, which suggests many of its recent troubles have been factored into the share price. Second, it yields a bumper 9.5%.

In March, management announced a 2.9% hike in the final dividend to 14p, but almost halved the special dividend to 8.3p. With cover down to one, today’s payout it is unlikely to be sustainable. However, given the dizzyingly high yield, it is likely to remain an attractive dividend income stock even if the payout is trimmed again.

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Harvey Jones 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.

Motley Fool UK 2019