Stocks offering a dividend yield of 7% or more can be very tempting. Dividend payouts at this level are sometimes quite safe, and can lead to the shares re-rating upwards as other investors pile-in.
Of course, some big dividends will get cut. In today’s article I’ll ask how safe three of today’s 7%-plus yields really are.
A heavyweight gamble?
Royal Dutch Shell (LSE: RDSB) currently offers a yield of 7.7%, but there are risks facing this payout.
Current City forecasts suggest that Shell’s $1.88 per share dividend will not be covered by earnings in 2016. The payout wasn’t covered last year, either.
Shell’s acquisition of BG Group means that future earnings and cash flow are less certain than previously. However, Shell has said several times that it intends to maintain the current dividend in 2016. I think we can be fairly sure of this.
Beyond this is less certain. Shell generated $5.6bn of free cash flow, but spent $9.4bn on cash dividends in 2015. Shell can afford to fill this gap using borrowed money, but only for a year or two.
I think there is good chance that Shell will avoid a dividend cut and rate the shares a buy. But this does depend on the oil market starting to recover over the next 12 months.
Boardroom bust up = bargain buy?
A profit warning less than one year after an IPO is considered bad form. The market punished building services firm Lakehouse (LSE: LAKE) severely when it warned on profits in February, pushing the shares down by 60% in one day.
Lakehouse said that the warning was due to cost-cutting in the social housing sector. Profits for the current year are now expected to be lower than they were last year.
The outlook became even more uncertain when small-cap specialist Mark Slater, who owns 6% of Lakehouse, teamed up with Lakehouse founder Steve Rawlings to call for some of the firm’s directors to be replaced.
It’s not entirely clear why Mr Slater is doing this. But Lakehouse has confirmed that it’s trading in line with expectations for the current year. This means that the shares trade on a 2016 forecast P/E of just 5, with a prospective yield of 7.2%.
There’s a risk of further problems. But based on the available information, Lakehouse shares look cheap to me.
Safer than Lakehouse?
Entu (LSE: ENTU) is another recently-floated housing stock that crashed after a profit warning. This is why I don’t invest in small company IPOs. The previous owner often chooses to sell because they think that conditions are about to get tougher.
However, Entu’s profit warning was the result of a specific issue last year. The firm decided to close its solar division after the government slashed the subsidies available for solar panels. Many other solar installers have also been affected.
Apart from this, Entu seems to have been trading well. The good news for us, as potential buyers, is that Entu shares now trade 35% below their IPO price.
Profits are expected to rise this year, and the shares have a forecast P/E of 5.8, and a prospective yield of 9.2%!
These shares may suffer in the next housing downturn. But despite this risk, I think they look attractive at the moment.
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Roland Head owns shares of Royal Dutch Shell. The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.