The Income Investor: a cyclical dividend stock in an ‘overlooked’ index

The FTSE 250 index reached a new record high earlier this month. Despite this, the index continues to offer a relatively appealing dividend yield. It currently stands at 3.2%, which is 20 basis points higher than the income return of the FTSE 100 index, with a large number of FTSE 250 members offering substantially greater dividend yields than the wider index at present.

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Indeed, 62 of its constituents have income returns in excess of 4%. This compares with just 22 stocks in the FTSE 100. As a result, it is somewhat surprising that investors frequently overlook the UK’s mid-cap index when seeking to build a diverse portfolio of income shares – especially when its impressive dividend growth potential and upbeat capital return prospects are factored in.

Growth potential

Of course, many income investors may focus on FTSE 100 dividend stocks due to their substantial international exposure. For example, in excess of 80% of UK large-cap index revenues are generated from outside the UK. This not only provides greater diversity, and therefore potentially lowers risk, but also offers access to relatively fast-growing economies that could allow for a brisk rate of dividend growth in future.

The FTSE 250 index, though, also offers significant international exposure. Its members, for instance, generate around 55% of their sales from outside the UK. And while the mid-cap index’s relatively large exposure to the UK economy has previously been viewed as a negative by many income investors, given its lacklustre growth rate, an increasingly upbeat outlook could mean that it provides buoyant operating conditions that allow for greater profits and rising dividends in future.

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In fact, inflation in the UK of 2.6% is currently lower than in other developed economies such as the eurozone (2.9%) and the US (3.4%). And with UK inflation currently forecast to fall by 30 basis points by the end of next year so that it is only marginally above the Bank of England’s 2% target, it would be unsurprising if the central bank begins to consider interest rate cuts over the coming months.

Once time lags have passed, further monetary policy easing could bolster the economy’s growth rate. The International Monetary Fund (IMF) currently forecasts a 1.3% expansion for the UK economy next year, for instance. This is 30 basis points up on the 2026 forecast and 10 basis points higher than the eurozone economy’s anticipated growth rate in 2027. As such, the FTSE 250’s higher domestic bias could prove to be an asset rather than a liability in terms of its impact on future dividend growth.

Sound fundamentals

Income investors may also favour FTSE 100 stocks over mid-cap companies due to their greater size and scale. This may typically be expected to equate to lower risks, in terms of them having a sound financial position and exposure to a relatively diverse range of customers, that allows them to more easily overcome the inherent ebbs and flows of the world economy. In practice, this could mean a more reliable stream of dividends for income seekers.

However, a substantial number of FTSE 250 members have sound financial positions and operate across a diverse range of market segments. This means that their risk profiles are relatively favourable and, on a long-term view, they appear to offer a solid, reliable income stream for investors.

Moreover, the FTSE 250 index’s earnings multiple of 15.3 is significantly lower than the FTSE 100 index’s price-to-earnings (P/E) ratio of 18.1. When combined with the superior yield of the mid-cap index, this suggests that its total return prospects could be more favourable than those of the large-cap index given its scope for a sizeable upward rerating.

Source: Refinitiv at 9 August 2026. Bond yields are distribution yields of selected Royal London active bond funds (as at 5-6 August on Trustnet), except the global infrastructure bond which is 12-month trailing yield for iShares Global Infras ETF USD Dist at 5 August. SONIA reflects the average of interest rates that banks pay to borrow sterling overnight from each other (5 August). Best accounts by moneyfactscompare.co.uk refer to Annual Equivalent Rate (AER) at 9 August and which exclude bonuses.

Risk/reward ratio

Undoubtedly, the FTSE 250 index could experience elevated volatility in future. After all, heightened geopolitical risks and ongoing economic uncertainty could weigh on both investor sentiment and the financial performance of its members.

But on a long-term view, income seekers should at least consider mid-cap shares when deciding which companies to hold in their portfolio. The FTSE 250’s relatively attractive yield, exposure to economies with upbeat growth prospects over the coming years and the sound fundamentals of many of its members mean its risk/reward opportunity appears to be favourable.

For example, FTSE 250 member Morgan Advanced Materials (LSE:MGAM) could offer relatively appealing long-term income investing prospects. The manufacturer of advanced carbon and ceramic materials that are used in a variety of applications such as wind farms and aeroplane engines has a dividend yield of 4.8%. This is 50% higher than the mid-cap index’s dividend yield.

An evolving outlook

Of course, the company’s dividend has risen by just 2% on a per share basis over the past three years. As a cyclical business, it has experienced challenging operating conditions in its key markets that have contributed to a 53% decline in its earnings per share (EPS) over the same period. And with the company seeking to build dividend cover from 1.3 last year to a figure of 2.5, material dividend growth is not anticipated in the short run.

On a long-term view, however, the company’s financial prospects and dividend outlook are far more upbeat. In the US, which accounts for 42% of the firm’s revenue and is its main geographical market, an inflation rate that is due to fall by 150 basis points to 2% by the end of 2028 is expected to prompt a looser monetary policy. Once time lags have passed, this could catalyse demand for the company’s products and lead to growing profits and dividends over the long run.

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Morgan Advanced Materials is also making significant changes to its structure as it seeks to focus on market segments that offer greater scope for fast-paced profit growth. For example, it is conducting a strategic review of part of its operations after making an asset disposal last year. When combined with an ongoing efficiency programme that is set to contribute to a 25% increase in its operating profit margin over the medium term, the company’s long-term financial outlook appears to be relatively upbeat.

It also has a sufficiently sound financial position through which to overcome potential near-term challenges in its key markets. For example, its recently released half-year results showed that it has a net debt-to-equity ratio of 85%, while net interest costs were covered five times by operating profits in the first half of the current year. A relatively solid balance sheet also means the firm has the capacity to reinvest in growth opportunities to further boost its financial performance.

Total return prospects

Morgan Advanced Materials’ EPS is forecast to rise at an annualised rate of 14% over the next two financial years. Given that its shares trade on a P/E ratio of 16 even after their 26% rise over the past year, they appear to offer good value for money and scope for attractive capital gains.

Moreover, the company’s sound strategy to maximise profitability, its solid fundamentals and increasingly upbeat operating outlook suggest it offers a favourable risk/reward ratio. Although a prospective lack of meaningful dividend growth in the short run may naturally dissuade some investors from focusing on the stock, its relatively high yield and scope for dividend growth in the coming years mean it appears to have income investing potential on a long-term view.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.