Profitability of 8.21% and a P/E ratio of only 5! This is my favorite passive income stock pick for October

The FTSE100 is packed with great value UK dividend stocks providing high rates of passive income, but why stop there? Smaller companies can also offer stunning yields, and some are mega cheap, including hidden ones FTSE250 gem.

OSB Group (LSE:OSB) caught my eye a few weeks ago. I would have bought it there and then, but I’m fully invested and have no spare cash. But I don’t give up.

OSB is a specialist mortgage lender that finances buy-to-let, self-employed, non-performing loans and commercial mortgages using retail deposits from its savings franchises Kent Reliance and Charter Savings Bank.

High yielding FTSE 250 stocks

OSB may not be a household name, but its roots date back to 1898, when it was founded as the Chatham & District Reliance Building Society. It was renamed Kent Reliance in 1986 and then floated as OneSavings Bank in 2014 at 170 pence per share.

Currently, OSB boards are sold in 390p resolution, but lately the performance has been inconsistent. Shares are up 16.97% over 12 months, but only 5.41% over five years (taking into account the pandemic, of course).

It has had a difficult three months, falling 13.1% following disappointing half-year results published on August 15.

The board lowered its full-year net interest margin forecast from 250 basis points to 230-240 points, blaming increased competition in the mortgage market. Markets expect the Bank of England to cut interest rates in November and December this year, which could further reduce OSB margins.

However, falling interest rates can have a positive effect, increasing activity in the real estate market and demand for mortgage loans.

But there is another danger. OSB is responsible for writing 9% of all new buy-to-let mortgages. Unfortunately, this is also limited. The press is full of landlords claiming they are selling, as tax breaks are reduced, to tenants gaining more rights and potentially tightening energy efficiency regulations.

Labour’s impending Tenants’ Rights Bill adds to the sense of fear, while higher borrowing costs don’t help. Maybe the panic was exaggerated, but perception still counts.

Possibility of cheap purchase

This risk is largely reflected in today’s low price-to-earnings ratio of just 5.15 times earnings. The reward, of course, is a huge rate of return of 8.21%.

So is the dividend sustainable? It is covered by 2.6 times earnings, which is comforting. In August, the board was pleased to increase the interim dividend by 5% to 10.7p per share. Dividends per share have been growing fairly steadily, but the rate of growth has slowed over the last few years, as the chart below shows.

Chart by TradingView

Nevertheless, the board was pleased to approve a new £50m share buyback which began last month.

The 10 analysts offering one-year OSB price targets set a median of 554p. That’s a 39.85% increase over today’s price. Imagine that plus 8% profit? Of course this is not guaranteed.

If markets recover, OSB may prove to be the leader. There are risks, but given the size of this second income stream, these will be the first shares I buy in October. I just need to raise the money.