I bought this 6.4% dividend-yielding stock to grow my passive income

In order to grow my passive income, I recently added UK homebuilder Barratt Developments to my portfolio despite the uncertainty in the UK housing market.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

a couple embrace in front of their new home

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Growing a passive income portfolio has several benefits, including valuation support in times of economic slowdown, income stability and the opportunity to reinvest dividends.

When a dividend-paying company sees its shares (and valuation) trend lower while maintaining its dividend, thereby increasing the yield, the market is anticipating a dividend cut at some point in the future. 

This is precisely what is happening with Barratt Developments (LSE:BDEV). However, I believe the dividend is unlikely to be paused — and if it is cut in the future, I do not believe it is likely to go below 4% (it’s currently 6.4%).

Why is the market pricing in a dividend cut?

Homebuilder profits are directly tied to home prices, production volume and building costs such as labour and raw materials that determine profitability. Home prices are driven by:

  1. Demand – mortgage rates (currently at 4.38%), average incomes and population growth.
  2. Supply – volume of new homes being built. 

Mortgage rates are likely to be much higher in 2023 than in 2021 or 2020, which is expected to cause a correction in UK house prices because a decrease is required to maintain payment affordability for home buyers.

Lower house prices will result in lower future profits for homebuilders like Barratt Developments, but this entirely depends on the rate of decrease in average house prices.

Despite negative sentiment towards homebuilders, the UK is still suffering from an undersupply of new homes as the target of building 300k (as per the Conversative party manifesto) new homes is far from being met.

Net new dwellings in 2021 was below pre-pandemic levels — according to the Department for Levelling Up, Housing and Communities — at around 220k. 2022/23 figures are expected to be higher, but they do not appear to be on target to reach 300k by the middle 2020s according to industry specialists.

Therefore, I would argue house prices will see some level of price support in a correction, unlike in the 2008 financial crisis. Furthermore, analyst estimates suggest a growing dividend over the coming years with annual distributions of 39p (FY22), 45p (FY23) and 51p (FY25).

Even if these estimates are reduced by 40% as a result of margin pressure and lower house prices, the dividend yield would still be relatively attractive at over 4% (18p+) given Barratt Developments’ investment-grade balance sheet and long-term potential.

Balance sheet built for recession 

As of 31/12/2021, Barratt Developments had over £1.33bn in cash and cash equivalents, meaning the £300m paid in dividends last year could easily be maintained. Barratt Developments comfortably covers its LT debt of £208m, thereby significantly reducing bankruptcy risk.

One area of weakness on the balance sheet is inventory, which is marked at £4.9bn. In a housing correction the value of this inventory could easily be marked down, resulting in additional losses or a more severe dividend cut.

Conclusion

Overall, I believe the market has already significantly de-risked Barratt Developments’ market capitalisation, making today’s valuation of £4.6bn attractive enough to open a small position.

I agree the current economic situation is likely to negatively impact UK house prices over the coming quarters, which is likely to result in earnings revisions and lower price targets.

Therefore I have only opened a small position, with the idea of averaging down as negative news and recession data mounts over the coming 12 months.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

George Theodosi has a position in Barratt Developments. 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.

More on Investing Articles

Investing Articles

How much does an investor need in a Stocks and Shares ISA to earn £1,000 a month in passive income?

A Stocks and Shares ISA's a valuable asset for investors. Not having to pay dividend tax can be a big…

Read more »

Investing Articles

9% dividend yield! Could buying this FTSE 250 stock earn me massive passive income?

Assura looks like an outstanding stock for dividend investors to consider. But is the 9% dividend yield the passive income…

Read more »

Man putting his card into an ATM machine while his son sits in a stroller beside him.
Investing Articles

Why I think this month could be critical for the Lloyds share price!

Our writer explains why he thinks the bank's 2024 results will have a significant impact on the short-term direction of…

Read more »

British Pennies on a Pound Note
Investing Articles

This former penny share has soared 168%. Is the best yet to come?

When Christopher Ruane saw a penny share as a potential bargain last year, he was spot on. So having not…

Read more »

Mature couple at the beach
Investing Articles

£20k in an ISA? Here’s how it could generate £1 of passive income every hour — forever

With a long-term approach, Christopher Ruane explains how an investor could aim to earn a pound per hour in passive…

Read more »

One English pound placed on a graph to represent an economic down turn
Investing Articles

FTSE shares: overpriced or still a bargain?

Christopher Ruane reckons a storming FTSE 100 performance of late doesn't tell us much about whether there are still possible…

Read more »

Blue NIO sports car in Oslo showroom
Investing Articles

Would an investor have made money investing £2k in NIO stock 5 years ago?

Our writer looks at how NIO stock has performed over recent years and weighs the bull and bear cases as…

Read more »

Young woman working at modern office. Technical price graph and indicator, red and green candlestick chart and stock trading computer screen background.
Investing Articles

5 steps to start buying shares with £5 a day

In a handful of steps, our writer explains how someone new to the stock market could start buying shares for…

Read more »