A surprising number of dividend stocks trade with yields of 7% or more at the moment. Such high returns can be great buying opportunities for savvy investors. But they can also be dividend traps — stocks where both the share price and the dividend are likely to fall.
Today, I want to look at two high-yield stocks that are in the news at the moment. Should we be buying?
Shares in FTSE 100 housebuilder Persimmon (LSE: PSN) fell by 6% in early trading on Monday morning. The dip was in response to weekend press reports that government Housing Secretary James Brokenshire is concerned about the firm’s use of leaseholds on new properties and problems with build quality.
The worry for investors is that nearly half of Persimmon’s sales are made using the government-funded Help-to-Buy scheme.
This scheme is due to be extended from April 2021 to March 2023. But my reading of this morning’s market reaction suggests that Persimmon may have to alter some of its commercial practices in order to continue participating in Help-to-Buy. This could put pressure on profit margins.
Persimmon’s most recent accounts show an operating margin of almost 28%. That’s significantly higher than direct rivals such as Redrow (20%) or Barratt Developments (18%).
Why is Persimmon so much more profitable? It’s not clear to me, but I think there’s a chance the company’s margins could fall to more typical levels over the coming years. For now, the 10% dividend yield looks safe. But I’ve downgraded my view on this stock to hold.
Another property stock whose management is facing investor criticism is shopping centre owner Hammerson (LSE: HMSO). Last year saw the company rejected a takeover bid at 635p per share and made a takeover offer for rival Intu, before changing its mind at the last minute. Hammerson shares now trade at just 365p.
Figures released by the company today show that its performance is continuing to suffer as a result of problems in the retail sector. Occupancy fell from 98.3% to 97.2% last year and new leasing activity dipped 17%.
The value of Hammerson’s property portfolio fell 5.9% to £9.9bn, while adjusted profit was 2.4% lower, at £240m.
The right time to start buying?
We don’t yet know how much further the value of retail property will fall. Big shopping centres are not sold very often, so it’s hard to get an idea of realistic market prices.
However, what we do know is that Hammerson shares now trade at a 50% discount to their net asset value of 738p per share. Such a wide discount is unusual. It could be a contrarian buying opportunity, or it might mean that further write-downs are likely.
What happens next?
Two key risks for investors are the group’s debt levels and the safety of the dividend. Management hope to cut debt this year by selling another £500m of property. But property sold last year was priced 7% below its 2017 book value. I suspect further discounts will be needed for sales this year.
So far, the dividend has been held, leaving the shares trading with a 7% yield. That’s tempting, but I feel management lack credibility after last year. In my view, there are better buys elsewhere in this sector.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Redrow. 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.