The second-largest holding in Neil Woodford’s £5.6bn Equity Income fund is FTSE 100 housebuilder Barratt Developments (LSE: BDEV), which currently offers a prospective dividend yield of 8.6%. With a portfolio weight of 6.7% at the end of the September (vs 0.2% for the fund’s benchmark – the FTSE All-Share index), Woodford is clearly bullish on the investment case for Barratt.
Given Woodford’s reputation, do I think private investors would benefit from following the fund manager and loading up on the stock for the huge yield?
Be careful of high yields
I’m not so sure. I’m always wary of a stock’s yield when it is higher than around 6%-7%. When a yield is up near 9%, you have to ask yourself why it is so elevated. In other words, why is the share price so low that it has pushed the yield up so high?
In Barratt’s case, investors are no doubt concerned about the state of the UK housing market, and this has pushed the P/E ratio down and the yield up. Even though we have a shortage of affordable housing in the UK, Brexit uncertainty, rising interest rates, increasing construction costs and high levels of consumer debt are all threats to demand growth. A recent profit warning from peer Crest Nicholson won’t have helped sentiment towards the stock.
A downturn in the UK’s housing market could have disastrous implications for Barratt’s dividend. Looking at the group’s dividend history, the group paid no dividend at all between 2008 and 2012 after the Global Financial Crisis (GFC) hit the UK housing market hard. Investors should note that the stock’s forecast dividend coverage ratio of 1.6 times is not that high.
There’s no sign that a dividend cut at Barratt is on the cards in the near future. Recently, the group raised its payout by 5% for the most recent financial year. However, there is an element of risk to the dividend going forward, in my view, especially with Brexit unknowns. As such, I’m happy to ignore Barratt’s high yield for now and focus on other, more dependable, dividend stocks.
Better dividend stock?
One I’d be more likely to buy right now is FTSE 250-listed merchant bank Close Brothers Group (LSE: CBG). The reason I say this is that the group has an excellent dividend growth track record and managed to hold its dividend steady during the GFC as other banks such as Lloyds and RBS were slashing their payouts left, right and centre. And since the GFC passed, the bank has notched up eight consecutive dividend increases, registering dividend growth of 62%, which is an excellent achievement.
CBG’s dividend yield certainly isn’t as high as Barratt’s. With analysts expecting a payout of 65.8p per share for the year ending 31 July 2019, the prospective yield is ‘only’ 4.5%. However, when you consider the company’s diversified business model, its dividend growth history, and also the level of dividend coverage (which is very solid at a forecast 2.1 times), there’s a lot of appeal in that yield in today’s low-interest-rate environment, in my opinion.
The last time I covered Close Brothers back in late September, the shares were up around 1,600p. However, after the recent market sell-off, they’re back at 1,465p which puts the stock on a forward P/E of 10.5. I think that’s a fair price to pay for a slice of this high-quality, dividend-paying bank.
Edward Sheldon owns shares in Lloyds Banking Group. The Motley Fool UK has recommended Lloyds Banking Group. 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.