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Have £2k to invest in an ISA? These FTSE 250 dividend stocks yield 10%

I rarely buy any shares which don’t pay a dividend. In fact, I’m slightly obsessed with income stocks and I’m always on the hunt for high yield opportunities.

Here, I’m looking at two FTSE 250 dividend stocks with serious income potential. Both companies offer dividend yields of about 10%. Held in a Stocks and Shares ISA, these could offer an attractive tax-free income.

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They are housebuilder Bovis Homes Group (LSE: BVS) and rival Galliford Try (LSE: GFRD), which also has a construction division. Earlier this week, the two firms announced plans to combine their housebuilding operations under the Bovis name, leaving Galliford as a dedicated construction business.

Should you buy these high-yield stocks after this week’s news? I’ve been taking a look at the latest numbers to find out more.

What’s the deal?

Bovis boss Greg Fitzgerald first approached Galliford about a possible deal back in May. Fitzgerald’s initial offer was turned down, but he’s now back with a more generous offer that seems to have won the backing of Galliford’s board.

In short, the £1.1bn deal would see Bovis take over Galliford’s housebuilding and regeneration businesses. Galliford shareholders would receive £675m of Bovis stock. Galliford itself would get £300m in cash. Bovis would also take over £100m of Galliford’s debt.

The Bovis CEO was previously the chief executive of Galliford, so he knows the business well. Both companies seem to be happy with the deal. Should shareholders vote in favour?

Is it a good deal?

The GFRD share price tumbled in April, when the group’s construction business was forced to book losses on various big contracts. This is a constant hazard for construction firms, and is one reason why I prefer to see this type of business run without debt.

Galliford’s latest accounts show an average net debt of £186m over the last year. Selling its housebuilding operations to Bovis would free up cash that’s tied up in housebuilding land and inventory. It would also cut debt and leave the construction business with a net cash balance, according to analysts’ estimates.

For Galliford, I reckon the deal looks good. What about Bovis? I don’t think Bovis needs a deal as badly as Galliford. But the firm only sells about 20% as many houses as FTSE 100 rival Barratt Developments. Increasing the scale of the business should deliver useful cost savings and provide new options for future growth. It’s not a bad idea.

Which is the best dividend stock?

Construction businesses like Galliford run with low profit margins and are always dependent on big contract wins. Costly problems are inevitable, from time to time. I wouldn’t buy a construction stock for income.

Meanwhile, housebuilders have problems with boom and bust cycles too, but Bovis is performing well at the moment and profit margins are high. This year’s forecast dividend yield of 10% looks affordable to me, regardless of whether the Galliford deal goes ahead.

However, I don’t expect the Bovis dividend to remain at this level forever. At some point, I expect housing market conditions to change, making life harder for housebuilders.

I don’t know how soon this will be. If you’re bullish about the UK economy, then I’d buy housebuilders. If you think we’re heading for a recession, I’d probably hold back. It’s your call…

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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.