I said in an article in February that housebuilder Taylor Wimpey’s (LSE: TW) then forward dividend yield of just over 8% was “attractive if you remain mindful of the cyclical risks.” Back then, the share price was at 190p and today it’s close to 166p, having been near 150p in October. I think those cyclical risks have been making themselves known.
Yet, the stock looks awesome on paper. The quality indicators look good, with the return on capital figure running near 22% and the operating margin above 20%. The valuation seems wonderful, with a forward price-to-earnings ratio at about 7.5. Then there’s that magnificent forward dividend yield that has breached 10% for 2019 – what could possibly go wrong if we invest now?
A big part of the dividend is at risk
One potential danger zone, I feel, is that most of that fat dividend is classified by the company as ‘special’. Around two-thirds of the 2018 payment is a special dividend with just the remaining third being classified as an ordinary one. The directors plan to keep paying the ordinary part of the dividend through any “normal” economic downturn, but the special dividend could be axed. I think there is a great hazard in that because if the special dividend gets the chop, I can’t imagine the share price doing anything else but plunging.
I think the stock market has been marking down Taylor Wimpey’s valuation because its profits have been growing. The big worry is that something will change in the property market to stop the housebuilders from earning ever greater profits year after year. Taylor Wimpey is, after all, a company running a highly cyclical business and the market ‘knows’ that big profits will cycle down again to smaller profits, it just doesn’t know when, so it’s keeping a lid on the valuation.
To me, that means the share price is unlikely to shoot up hard and fast in the near future. However, what I do think is that it will be volatile from now on. As soon as there’s the merest suggestion of a slowdown, the share price will likely react by plunging, just as we’ve seen over the past month or so. Meanwhile, City analysts following the firm don’t expect much in the way of growth in earnings — just 4% this year and again next year, which is a long way from the robust double-digit advances we’ve become used to recently.
Earnings are starting to look toppy to me, even though the company is making plenty of positive noises about operations and forward trading. So I think the big dividend will remain, and the valuation will stay low, perhaps for years, with the share price wiggling up and down in an uneasy state of anxiety. But one day, I believe the dividend, share price and earnings will all plunge together. In the meantime, the stock should continue to flaunt its attractions, like a Venus flytrap ready to snap shut when the time is right. You could fly in and drink the nectar of that yield, and you could get away with it, time after time… until you don’t!
Kevin Godbold 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.