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Why I’d sell this FTSE 250 flyer to buy this dividend growth stock

Peter Stephens

While it’s never easy to sell a stock that has generated high returns, doing so may be beneficial to the future prospects of a portfolio. In many cases, it may be possible to obtain a wider margin of safety elsewhere and this could have a positive impact on the overall risk/reward ratio of a portfolio of investments.

With that in mind, reporting on Friday was a FTSE 250 company which now seems overvalued after its 50% share price gain in the last year. By contrast, an index peer could be worth buying for its dividend growth potential.

Strong performance

The company releasing a trading update on Friday was IT infrastructure services provider  Computacenter (LSE: CCC). Its first quarter performance was better than expected, delivering a rise in revenue of 23%. However, this figure was inflated by a one-off software licence sale in the UK of £34.1m. This increased revenue, but had the impact of diluting margins during the period.

The company appears to have a bright future from a business perspective. Its Supply Chain segment is seeing rising demand for its services, as customers seek to digitalise their businesses. This is set to contribute to a rise in earnings of 4% in the current year, with a further increase of 5% forecast for the next financial year.

Following Computacenter’s 50%+ share price gain in the last year, it now trades on a price-to-earnings (P/E) ratio of around 21. This is a rating which is normally applied to a growth stock and suggests that the market may have become over enthusiastic about the company’s prospects. With low-single digit earnings growth and a high rating, now could be the right time to sell it.

Encouraging outlook

While the performance of the UK car industry has disappointed in recent periods, used car sales could prove to be more resilient than many investors realise. Online sales company Auto Trader (LSE: AUTO) is expected to generate earnings growth of 11% per annum over the next two years. This follows double-digit net profit growth in the last two years and suggests that it could have a solid business model that is capable of performing well in a variety of market conditions.

Since the stock trades on a price-to-earnings growth (PEG) ratio of 1.6, it appears to offer a wide margin of safety. Therefore, it could be of interest to growth investors who are looking for mispricing opportunities in a bull market.

Furthermore, Auto Trader could become an enticing income play over the medium term. The company is expected to increase dividends per share by 17.7% per annum over the next two years. While this puts it on a forward dividend yield of just 2.1%, it could deliver further dividend growth in future since its payouts are covered over three times by profit.

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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has recommended Auto Trader. 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.