These FTSE 250 dividend stocks look dangerously overvalued

Brexit Burning Money Destroying Wealth

While questions over the consequences of Brexit in the near term and beyond continue to circulate — and are unlikely to be answered for some time yet — investor appetite for stocks that have already been whacked by last June’s ‘leave’ vote has boomed in recent months.

Indeed, embattled outsourcers Capita Group (LSE: CPI) and Mitie Group (LSE: MTO) have both seen their share prices leap in recent months.

Although still trading at an 47% discount to levels seen on the eve of the referendum result, Capita has picked up more recently and touched its highest since November earlier this month. And its FTSE 250 peer has fared even better, a share price spurt this month leading it to trade just 11% lower from levels seen on the day of the EU vote.

Investment questions

But the investment community is being just a bit too hasty jumping back in now, in my opinion. Both companies have had to issue a stream of profit warnings since the autumn as trading activity has slowed down. And recent economic data suggests that the revenues outlooks at both Mitie and Capita remain less-than-compelling.

The Bank of England’s latest inflation report this month led many to claim fears of cooling business investment had been overdone.

The Old Lady of Threadneedle Street suggested that the near-term outlook had improved since its last report in February, with supportive credit conditions, resilient demand and the incentive created by weak sterling for exporters to invest prompting businesses to pull out their chequebooks once again.

However, the Bank noted that “a number of exporters and foreign‑owned firms remain cautious about larger investment decisions due to uncertainty around future UK trading arrangements.” And it said that this caution could be set to persist, adding that “uncertainty surrounding the United Kingdom’s future trading arrangements is likely to weigh on firms’ investment intentions in coming years.”

Lasting woe?

With no signs of an imminent upturn in spending, the City expects Capita to endure a 4% earnings fall in 2017, following on from last year’s 20% slide. And given the possibility that this bottom-line weakness could well last beyond this year, and these forecasts suffer severe downgrades in the months ahead, I do not think a forward P/E ratio of 10.5 times is attractive enough to tempt savvy investors.  

Likewise, Mitie Group is predicted to have suffered a shocking 50% earnings drop in the year to March 2017, although it is expected to rebound with a 31% rise in the present period. However, this forward projection still creates a shockingly-high P/E multiple of 14.6 times and, given that conditions are still yet to improve on the ground, this heady rise looks a tad optimistic to me.

The business advised just last month that revenues flatlined in the last fiscal year, “reflecting what has been a challenging environment.”

Patchy projections

Given this backcloth, I think stock pickers should ignore predictions of chunky dividends and invest elsewhere. And they are undeniably chunky. In 2017 Capita is anticipated to maintain the 13.7p per share of the past two years, yielding 5.7%.

Mitie, meanwhile, is predicted to bounce from a severe dividend cut (a 7p payout is expected for fiscal 2017, down from 12.1p in the prior year) and to lift the reward to 7.8p. This forecast yields a market-beating 3.7%.

But until more clarity surrounding the UK economic outlook becomes apparent, I believe both outsourcers are a risk too far at present.

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Royston Wild 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.

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