Even among housebuilders, the 10% dividend yield on offer at Taylor Wimpey (LSE: TW) is unusually high. I’ll explain here why this is a stock I’d continue to hold. I’ll also highlight a FTSE 100 share where I think the outlook for dividend investors is poor.
£600m dividend windfall
Taylor Wimpey has confirmed plans to declare £600m of dividends in 2019, a 20% increase from last year’s payout of £500m. At current levels, my sums suggest shareholders should receive a 2019 dividend of 18.3p per share, giving a forecast yield of about 10.5%.
The good news is that the cash needed to fund this payout is already in the bank. The FTSE 100 housebuilder reported net cash of £644m at the end of 2018, up from £511.8m a year earlier.
These figures give us a pretty clear idea of the group’s dividend policy at the moment. Essentially, it’s returning all of its net cash each year to shareholders. That’s good news for now. But what happens if the cash dries up?
Stress testing the dividend
Today’s figures show Taylor Wimpey’s underlying pre-tax profit rose by 5.5% to £857m last year, giving earnings of 21.3p per share.
However, City brokers have pencilled in earnings of 20.5p per share for this year, a fall of nearly 4%. This isn’t something I’d worry about. But in my view, the cyclical nature of the housing market means investors should be prepared for a much bigger fall at some point.
If that happens, what would the impact be on the firm’s dividend? The board’s aim is to pay a dividend of £250m per year (7.5p per share) “throughout the cycle.” This would give the stock a basic yield of 4.4%, even during what the firm describes as a “normal downturn.”
Management says a £250m annual payout has been “stress-tested” in various scenarios, including a 20% fall in house prices and a 30% fall in volumes.
I don’t know how reliable this dividend will be. But if the promise of a 4%+ yield that’s topped up with extra cash whenever possible seems attractive to you, then Taylor Wimpey could be worth buying at current levels.
This yield looks too low to me
Utility stocks aren’t big growers. So, as a general rule, these shares are bought by income investors who look for chunky dividend yields.
However, investors hunger for income means that water utilities in particular have traded at quite high valuations in recent years. Severn Trent (LSE: SVT) shares now trade on 15 times 2018/19 forecast earnings, with a dividend yield of just 4.6%. That’s only slightly above the FTSE 100 average of 4.5%.
The water group’s lower yield has been acceptable in recent years, because the payout has risen by about 7% per year in most years. But a new regulatory pricing regime for water utilities comes into force next year. Analysts expect this to restrict Severn Trent’s earnings growth to less than 3%.
If this is correct, I think that dividend growth is also likely to slow. On that basis, I’d aim to buy the shares when they’re yielding over 5%. That’s equivalent to a share price of under 1,800p.
At more than 2,000p, I see Severn Trent as fully priced, if not expensive. I’d stay away for now.
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.