A dividend stock which could offer over 30% in capital gains within two years may seem unlikely. After all, many investors consider dividend stocks to be somewhat stale when it comes to capital growth potential. However, reporting on Friday was a stock which alongside its 5.7% dividend yield could offer stunning share price gains between now and 2019.
Improving performance
The company in question is motor and home insurance specialist Esure (LSE: ESUR). It recorded a rise in gross written premiums of 19% in 2016, with in-force policies up 8.6% to 2.174m. This enabled it to post a rise in underlying profit after tax of 18%, which pushed total dividends higher by 2p per share to 13.5p. This means that the company now has a payout ratio of 70% of underlying earnings per share, which is inclusive of a 20% special dividend.
Esure’s combined operating ratio increased by 1 percentage point to 98.8%, while the business appears to have a strong capital position. Its Group coverage stands at 149% versus 123% last year and with the demerger of GoCompare.com having been successfully completed, it seems to be well-placed to deliver improving financial performance in future years.
Growth potential
While Esure’s earnings are due to fall by 13% in 2017, the company is forecast to return to positive growth in 2018. Its bottom line is expected to move 8% higher next year, which indicates that investor sentiment could begin to improve. This has the potential to push the company’s price-to-earnings (P/E) ratio higher than its current level. Since it trades on a P/E ratio of 12.4 versus a historic average of 22.6 over the last four years, an upward re-rating seems to be relatively likely.
If Esure was to revert to its historic average P/E ratio and meet its forecasts for the next two years, its shares could be trading as much as 72% higher than they are today. Clearly, this is an ambitious target, so investors may wish to include a margin of safety in case the company’s outlook is downgraded. As such, a capital gain in excess of 30% by 2019 does not appear to be overly optimistic.
Sector potential
While Esure could prove to be a strong buy for the medium term, sector peer Admiral (LSE: ADM) could offer even greater growth potential between now and 2019. It is forecast to record a rise in its bottom line of 37% in the current year. This puts its shares on a price-to-earnings growth (PEG) ratio of just 0.5, which compares favourably to Esure’s PEG ratio of 1.4. As such, there seems to be a wider margin of safety on offer with Admiral’s shares when compared to those of its sector peer.
Furthermore, Admiral currently yields 5.9%. This is 0.2% higher than its sector peer’s yield and since Admiral has a track record of relatively stable dividends, it could prove to be the more reliable dividend stock in the long run. Both companies could suffer from changes to the personal injury discount rate in the short term, but they seem to offer strong growth prospects for the long term.