Sometimes the FTSE 100 throws up such a dirt-cheap bargain that I have the urge to cast all caution aside and buy it, despite the risks. I think I have found just such a stock.
Housebuilder Persimmon (LSE: PSN) offers the kind of dividend yield that would normally have me running a mile. Incredibly, it pays income of 18.56%. That is almost double the current inflation rate.
This is a massive income stock
I would normally view a massive yield like this as a red light rather than a green one. Yield is calculated by taking the dividend per share, and dividing it by the company’s share price. This means when the share price falls, the dividend automatically rises. A high dividend is therefore normally a sign of a collapsing share price.
A quick look at Persimmon’s stock chart confirms that’s the case here. It’s a sea of red. In the last week it has fallen 7.02%. Over 12 months, it is down 51.03%. Measured over five years, it is down 45.45%. Those are horrible figures.
Bargain-seekers who loaded up on Persimmon stock over that period will be licking their wounds. Each drop has been followed by another. The comeback never comes.
I accept that I could quickly find my name enrolled on the lengthy list of losers. UK house prices finally look vulnerable as the cost-of-living crisis intensifies. Affordability is at an all-time high of 9.1 times the average salary, up from 3.55 times in 1997. That’s as dizzying as the Persimmon yield. Neither may be sustainable.
While the stamp duty cut and shortage of property supply will partially offset this, at some point buyers will find purchasing new homes too expensive. Especially if the current sterling crisis forces the Bank of England to hike interest rates even more aggressively.
Yet I would still buy this stock. If Persimmon didn’t face extreme headwinds, it wouldn’t be trading at a crazily low forward valuation of 5.5 times earnings. And the yield wouldn’t be so high.
The FTSE 100’s biggest yielder
Its current dividend is covered just 1.1 times earnings, as is the forward yield of 16.3%. It could make up any shortfall from its £780m cash holdings, but can’t keep doing that. Management may simply decide the yield is embarrassingly high, and chop it. Yet even if the payout was slashed in half, it would still yield 8% or 9% a year.
Another danger is that inflation will drive up building costs, although management has partly protected itself by bringing many of its operations in-house. Pre-tax profit for the six months to June 30 did fall, from £480m to £439.7m, while revenue and completions fell too.
Yet Persimmon is still on course to hit up to 15,000 completions for the full year, with forward-sales rates at 90%. Operating margins are 26.6% and the return on capital employed is 27.4%. It’s hardly a company in peril.
The big, big risk is that house prices crash, Persimmon shares fall further and the shareholder payout is cut. Yet I think today’s crazy dividend and valuation justify taking a risk with a small corner of my portfolio. I’m holding for a minimum 10 years, ideally 20, or more.
