Investing for a second income? This overlooked bank offers a 6% dividend yield

Millions of us invest for a second income. This typically means building a portfolio over time — ideally within a Stocks and Shares ISA wrapper — and then taking a second income in the form of dividends when that desired figure has been reached.

One stock that I like for both its dividend and value is Arbuthnot Banking Group (LSE:ARBB). It’s an AIM-listed company that, unlike its FTSE 100 peers, hasn’t surged over the past two years.

In fact, the stock is pretty flat over three years, and during that period, dividend payments have grown steadily from 42p per share in 2022 to an estimated 53.5p this year. This has pushed the forward yield above 6%.

It’s also a pretty secure-looking dividend. No dividend is perfectly safe, but as investors we should look for a dividend coverage ratio close to, or above, two. This means that net income is twice the amount allotted for dividend payments.

Arbuthnot’s dividend coverage ratio is forecast at 2.08 for the forward year. This suggests there’s very little chance of it being cut or cancelled. It also suggests there’s room for further expansion of the dividend in the coming years.

And that’s exactly what the forecast suggests. As earnings are expected to rise by 19.4% in 2026, there’s some expectation from analysts that the dividend will push up further. Based on today’s price, the yield could be 6.5% in 2026.

Balancing risk

Clearly, on balance, I believe it’s absolutely a stock worth considering.But there are some clear reasons why investors aren’t flocking into Arbuthnot.

First among these reasons is the spread between the buying and the selling price. As soon as someone buys the stock they’re 3%-4% down because of this phenomenon with smaller listed companies.

Next, it’s another size issue. Investors assume that smaller banks are less resilient in times of economic stress, with limited capacity to absorb shocks compared to larger, more diversified peers.

This perception often leads to smaller banks trading at a discount, even when their underlying fundamentals remain sound.

However, Arbuthnot’s relatively low loan-to-deposit ratio of 57.6% indicates that it lends out just over half of the deposits it holds, thus keeping a sizeable liquidity buffer.

This conservative position means the bank is less exposed to funding pressures or credit losses during periods of economic stress.

In other words, even if market conditions deteriorate or loan defaults rise, Arbuthnot has ample deposits relative to its lending, reducing the risk of a liquidity shortfall.

For me, this negates some of that size-related risk. By comparison, Lloyds’ loan-to-deposit ratio is 96%.

The big bonus

Arbuthnot also looks undervalued on earnings-based metrics. The stock trades at eight times forward earnings, with this figure falling below six in 2027. That’s cheaper than all the major FTSE 100 banks.

The price-to-book (P/B) ratio of 0.53 suggests its trading way below book value. Its FTSE 100 peers are trading with P/B ratios above one. This is also contributes to why analysts believe it could be undervalued by 69%.

The post Investing for a second income? This overlooked bank offers a 6% dividend yield appeared first on The Motley Fool UK.

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James Fox has positions in Arbuthnot Banking Group Plc and Lloyds Banking Group Plc. The Motley Fool UK has recommended Lloyds Banking Group Plc. 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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