This stock could yield as much as 10%

Housebuilder Redrow (LSE: RDW) has released a positive AGM statement. The encouraging sales trend it reported in September has continued, with Redrow having experienced no major slowdown in demand following the EU referendum. Looking ahead, its financial performance could improve and this could mean a sharp rise in its dividend.

Redrow said it has seen a rise in net private reservations of 6% versus the same period of last year. Its sales rate for the 19 weeks to 4 November was up 4% year-on-year and the average selling price of properties was also up slightly on last year at £341,000 versus £334,000. This shows that while house price growth has slowed somewhat, the UK housing market has remained buoyant, despite uncertainty surrounding Brexit.

Looking ahead, Redrow remains confident in its future outlook. However, 2017 could prove to be a tough year for the wider industry as uncertainty surrounding Brexit may increase and cause demand for new homes to rise at a slower pace than it has done in recent years. Although this could slow down Redrow’s pace of earnings growth, the business remains in good shape and was able to keep net debt to £92m. This shows that the firm’s balance sheet is relatively robust.

Income potential

However, the real potential for investors when it comes to Redrow is around its income prospects. The company may yield only 3%, but it pays out just 22% of profit as a dividend. This provides scope for a much higher dividend that would still be highly affordable even if profitability fails to rise at a rapid rate.

For example, if Redrow paid out two-thirds of profit as a dividend each year, it would equate to a dividend yield of around 9.6%. Not only could this boost investor demand for the company’s shares, it would also leave the business with sufficient capital to invest in future growth.

Of course, Redrow isn’t the only housebuilder with excellent income prospects. For example, Barratt (LSE: BDEV) currently yields 7.1%. Unlike Redrow, Barratt pays out 67% of its profit as a dividend, which doesn’t negatively impact its financial strength or ability to reinvest for future growth. However, it means that Barratt is more reliant on profit growth in order to boost its dividend, while Redrow could raise dividends at a much faster pace than earnings growth over the medium term.

Furthermore, it currently trades on a lower price-to-earnings (P/E) ratio than Barratt. It has a P/E ratio of 7.3 versus 9.1 for its industry peer. As such, Redrow has greater upward rerating potential, which when combined with its dividend growth potential means that it may prove more popular than Barratt for long-term investors. As such, and while both stocks offer excellent total return prospects, Redrow is the better buy at the present time.

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Peter Stephens owns shares of Redrow. The Motley Fool UK has recommended Redrow. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.