18% per annum: is this dividend stock too good to turn down?

Jon Smith scratches his head over a dividend stock that has a very high yield, but appears to be that way for a particular reason.

| More on:
Chalkboard representation of risk versus reward on a pair of scales

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.

At a general level, the dividend yield of a stock is related to the risk it carries. A stock with a 2% yield usually has a lower risk of the income being cut than a stock with a 10% yield.

Of course, there are exceptions to every rule. So when I spotted a dividend stock with an 18% yield, it caught my interest.

Details of the firm

I’m talking about VPC Specialty Lending Investments (LSE:VSL). It’s rather a mouthful to say, although the name does give a good indication about what the company does. It makes credit investments, lending out money in niche areas such as small business lending, working capital products, consumer finance and real estate.

Due to lending to some more unusual areas of the market, it can often charge higher rates of interest. The profit generated from this, alongside other business operations, provides it with money it can use to pay out as a dividend to shareholders.

It typically pays out four dividends a year. Over the past 12 months, it’s been 2p a quarter. When I add this up and compare it to the current share price, I get a dividend yield figure of 17.84%. This is clearly an ultra-high-yield stock!

A big disconnect

Digging into the business further, I can see why the yield is so high. The share price has fallen by 44% over the past year. This has acted to push the yield up and up.

The company blamed several factors during the 2023 annual report. This ranged from the impact of inflation to high interest rates that put pressure on businesses. It also flagged up that the share price is trading at a large discount to the actual net asset value (NAV) of the investment in the portfolio. This is true, in fact it’s currently at a 43% discount.

In my experience, such a large disconnect usually occurs due to negative investor sentiment. If they believe the company’s unlikely to do well in the future, they might sell the stock despite it being lower than where it should be in theory (on par with the NAV).

This is a bit of a red flag to me when I’m considering whether to buy the stock.

Too much for me

With a market-cap of £126m, VPC isn’t a huge listed company. It’s not a penny stock, but it’s not far away. The risk that’s associated with buying a stock of this size for income is very high. My concern is that the high yield is being driven mostly by the share price fall over the past year. Therefore, I don’t feel it’s massively sustainable as a long-term investor.

I could be wrong, with the share price eventually returning to a fairer level that’s more in line with the NAV. If I bought now and that did occur, I’d be laughing as I’d lock in the yield but also benefit from my capital appreciation!

Ultimately, I think this is a high-risk play. It’s not to say it won’t work out well, but I think I’ll look for some lower-risk options at the moment.

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.

Jon Smith has no position in any of the shares mentioned. 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 Dividend Shares

Investing Articles

After its big fall, is the National Grid share price dirt cheap now?

The National Grid share price fell sharply in reponse to new rights issue plans. But is it an even better…

Read more »

Young black colleagues high-fiving each other at work
Investing Articles

Despite its drop, I reckon this is one of the best FTSE 100 stocks to buy and hold!

The FTSE 100 has been climbing in 2024 but this favourite of our writer's has been falling. Despite this, she’s…

Read more »

Investing Articles

This UK Dividend Aristocrat just raised its payout for the 45th year in a row

Christopher Ruane runs his rule over a Dividend Aristocrat in the FTSE 100 that has announced its 45th consecutive 5%+…

Read more »

Passive income text with pin graph chart on business table
Investing Articles

Could these 2 recovering UK stocks become future passive income heroes? 

Earning a passive income from shares won't happen overnight. Looking ahead for future dividend heroes is a key part of…

Read more »

2024 year number handwritten on a sandy beach at sunrise
Investing Articles

1,904 shares in this 9.39% yielding UK stock would pay me a £100 monthly income

Harvey Jones is stunned by the passive income paid by this top UK stock. It's one of the highest on…

Read more »

Bronze bull and bear figurines
Investing Articles

Which is the better bank buy right now: Lloyds shares or HSBC?

HSBC pays a much higher yield than Lloyds shares, has much more value left in its share price, and doesn't…

Read more »

many happy international football fans watching tv
Investing Articles

6.4% yield! Is ITV a dividend stock to consider buying during the Euros?

Our writer takes a look at ITV and assesses whether the FTSE 250 dividend stock might be a good fit…

Read more »

Illustration of flames over a black background
Investing Articles

Up 915% in a decade! This growth monster may also be the best FTSE income stock of the lot

Harvey Jones has been watching this top FTSE 100 growth and income stock for months and now he's found another…

Read more »