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I think this 5% dividend yield could be going cheap and here’s why

While some investors like to chase the latest trend or the latest mining minnow that’s trending on Twitter, I prefer to find undervalued shares. I think I may have found one in my recent research and it’s in an industry out of favour industry with investors – housebuilding. I think Redrow (LSE: RDW) combines a fantastic dividend yield with great value. This combination, I believe, makes it cheap and a great share to buy and hold for the long-term.

Housebuilders under the cosh

Brexit hasn’t been kind to many industries, except perhaps financial advisors, polling companies, lawyers and insolvency experts. For housebuilders, the uncertainty has seen the whole industry become unloved by investors, pushing down share prices and pushing up dividend yields across the board. Adding fuel to the investor concerns is the weaker buy-to-let market (it had massively helped the industry after the last recession) and increased demand for trade skills, which has pushed up costs. Scandals over executive pay, particularly at Persimmon haven’t helped either.

Taken together, all these factors have been deterring investors from pouring money into a sector that had for a number of years seen share prices outperforming many other industries. While those good old days may not return any time soon, I think eventually they will, and in the meantime the share prices of the builders like Redrow are looking dirt cheap.

Solid foundations

Redrow in particular for me exhibits solid financial foundations. The P/E of six is at the low end of the sector average. For context, Persimmon has a P/E of just under seven and Bellway about 6.5. What makes Redrow a cut above for me though, is its ability to grow earnings. I calculate that its EPS growth is around 22%, versus around 14.2% for Bellway.

Indicating that the share price is cheap is the low price/earnings growth ratio. For both Redrow and Bellway the price is below the 0.7 that growth investors like the late Jim Slater recommend. In the case of Redrow, the figure is 0.29. This really indicates that investors are buying a company that is priced cheaply despite being very profitable and growing earnings.

The dividend is well covered and based on last year’s figures, it was covered about three times by earnings, meaning the prospect of a dividend cut is very unlikely. As well as that security, the dividend has been growing by about 18% on average in the last three years and the shares now yield around 5.4%. 

The future

Although it’s impossible to know the effect Brexit will have on housebuilders, it’s likely that demand will continue to outstrip supply. This fundamental imbalance will keep the housebuilders in business and more than that should keep them healthily profitable. I see little prospect of housebuilders like Redrow not continuing to reward investors for many years to come and in the meantime, the shares right now are high-yielding and very cheap. While the future is uncertain, that much is clear.

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Andy Ross owns shares in Redrow and Persimmon. 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.