As an income investor, I’m obviously wanting to get the highest potential out of any dividend share I buy. This is especially true in the current economic climate, where inflation is eroding the value of my money.
Yet eye-catching dividend yields warrant further attention, as sometimes things can be too good to be true. So with a FTSE 100 income stock offering a 18.5% yield at the moment, it’s time to dig deeper.
Let’s look at the figures
The company I’m referring to is Persimmon (LSE:PSN). The UK homebuilder has paid out two dividends over the past year, totaling 235p. Using a share price of 1,270p, it gives that dividend yield of 18.5% This currently makes it the highest yielding stock in the entire lead index.
To understand why it’s such a high figure, I need to appreciate what influences the dividend yield. If the share price falls, the dividend per share is a greater proportion of the share price. This boosts the yield. Sometimes, a dip in the share price can be a great opportunity to buy a stock, thanks to the higher yield.
The Persimmon share price has fallen by 54% over the past year. This is a sizeable move, unfortunately making it one of the worst performers in the FTSE 100 for 2022.
Clearly, this is a red flag. The high dividend yield is being caused by the steep fall in the share price.
A tricky year for Persimmon
Property stocks are cyclical in nature. What this means is that during an economic slowdown, the sector tends to underperform. This ties in as at this stage of the cycle, interest rates are typically rising. In turn, this puts pressure on new home sales due to mortgages becoming more expensive.
Given the timescale involved in building and selling a house, a good metric to look at is the forward order book. In a recent trading update, the business had £0.77bn of forward sales reserved beyond the current year. The comparative figure for 2021 was £1.15bn. From this I can see that the demand in the market is slightly depressed.
My take on this income stock
Despite the lower demand in the property space, I’m conscious that the business has strong profit margins. As a result, cash flow is good and balances healthy. It has a projected cash position of £700m for the end of the year, even after returning £750m in capital this year already.
So from a dividend perspective, I feel that Persimmon could continue to be generous in the payments. However, the company has introduced a new capital return programme. Although we don’t know what this means in hard cash, the principles are more tempered. It speaks of “operating prudently”, “retaining sufficient capital” and ensuring dividends are “well covered by post-tax profits”.
I think this is setting up for a reduction in the dividend per share over the next year. It would make sense, given that profits are likely going to be lower. The dividend yield at 18.5% just looks too high to be sustainable for years to come.
Based on the change in policy and the steep fall in the share price, the catch if I bought the stock now is pretty clear. As a result, I’m looking for dividend options elsewhere.
