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Should you buy FTSE 100 firm Taylor Wimpey for its 8.8% yield?

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Today I’m looking at one of the most controversial stocks in the FTSE 100. Housebuilder Taylor Wimpey (LSE: TW) offers a forecast dividend yield of 8.8%.

This mouth-watering income is covered by the group’s forecast earnings, and by its £525m net cash balance. So there’s very little risk of a dividend cut this year.

Despite this, investors are still selling the stock. Taylor Wimpey shares are worth 12% less than they were at the start of the year.

What’s the problem?

During the first half of this year, the High Wycombe-based firm sold £1.7bn of housing, broadly unchanged from last year. Adjusted pre-tax profit was down 1.2% at £331m and the group’s operating profit margin was almost unchanged at 20%.

Forward orders were 5.7% higher, at 9,241 homes. These numbers all seem quite encouraging to me.

However, as my Foolish colleague Graham Chester explained here, housebuilders are starting to look like they could be at the tail end of a long boom.

Listed estate agents such as Foxtons and Countrywide are reporting a steep drop in sales of second-hand homes. With interest rates starting to rise, will new-build sales also slow?

Not so cheap after all?

Taylor Wimpey shares look cheap relative to earnings, with a forecast P/E ratio of 8.3. But at current levels, this stock trades at two times its net asset value.

This valuation reflects the profits that are expected when its land bank is developed. But if sales slow or prices fall, then profit guidance could also be cut.

One possible saviour is the rising demand for rental homes. This might offset any fall in demand from homebuyers. Build-to-rent is certainly one option that could keep Taylor Wimpey’s profits flowing.

As things stand, I’d continue to hold this stock for income. But I think shareholders should be ready to jump if the market does turn.

A safer 6% yield?

One interesting alternative to housebuilders is brickmakers. Housebuilders generally prefer to buy bricks made in the UK, because transport costs are high relative to the value of the bricks.

One consequence of this is that UK brickmakers have been working flat out in recent years. FTSE 250 firm Ibstock (LSE: IBST) was recently forced to issue a profit warning because it needs to schedule in some downtime for maintenance in its factories.

The resulting sell-off means the firm’s shares are now slightly cheaper than they were at the start of the year. Thursday’s half-year results suggest to me that this could be a buying opportunity.

Cash + growth potential

In the near term, Ibstock shareholders will receive a 6p per share special dividend using cash received from a property sale. Brokers were already forecasting a payout of 13.8p per share for the current year, giving a forecast yield of 5.8%. I believe the total payout may now be higher than this.

Looking further ahead, Ibstock appears to offer decent growth potential. A new factory in Leicester is nearing completion. The group’s maintenance programme should be finished by the middle of 2019, allowing all factories to return to full production.

Like Taylor Wimpey, Ibstock could suffer in a housing downturn. But by investing in a brickmaker, you should get exposure to a much wider range of building projects than with a single housebuilder.

Trading on 12 times forecast earnings with a 5.8% yield, Ibstock might be worth considering.

Buy-And-Hold Investing

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Roland Head 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.