Housebuilders have been on a roll this year, and last week’s Conservative election win gave the sector another shot in the arm.
Today’s trading update from Barratt Developments (LSE: BDEV) was a case in point. Full-year sales are expected to be 16,100, above previous guidance and significantly ahead of last year’s total of 14,838.
Forward sales are 17.9% higher than they were at the same time last year, and Barratt even commented that the current market conditions are enabling the firm to increase sales at “legacy, low margin” sites — developments where sales have previously been problematic.
As you’d hope, Barratt is currently generating plenty of surplus cash, and is expected to payout 23.3p per share in dividends this year, rising to 28.8p per share in 2016. These forecast payouts equate to prospective yields of 4.1% and 5.1% respectively, highlighting Barratt’s attraction as an income share.
There is a downside
On the other hand, even the most bullish housing investor will probably agree that the UK housing market operates in cycles.
At some point, there will be another housing market crash. Property prices will fall, and Barratt’s dividend will probably be cut — remember, Barratt did not pay a dividend between 2009 and 2013.
Can such a cyclical stock be a good income investment? In my view, it can, as long as you are willing to ride out the troughs, or contrarian enough to buy when everyone else is selling, and sell when everyone else is buying — which can be difficult.
I suspect Barratt could be a profitable income play for several more years, although I would watch carefully for any sign that rising costs are putting pressure on profit margins.
How about Admiral?
Another popular income choice is car insurer Admiral Group (LSE: ADM), whose shares slipped slightly today after the firm announced that its charismatic founding chief executive, Henry Engelhardt, who has been in charge since 1991, will stand down in May 2016.
Admiral’s business model, which involves reinsuring most of its customers’ policies, means that the firm generates a lot of surplus cash, which Admiral returns to shareholders in the form of special dividends.
Current forecasts suggest that Admiral will pay a total dividend of 89p this year, giving a prospective yield of 6%.
That’s very attractive, but it is nearly 10% lower than last year’s payout, which in turn was down 1p from 2013. The Admiral cash machine appears to be in danger of stalling, as competition in the motor insurance industry continues to limit insurers’ ability to increase insurance rates.
However, this isn’t necessarily a reason not to choose Admiral for income: as with housebuilders, insurance companies’ dividends are often variable. Rather than rising continually, they go through good and bad patches, depending on market conditions.
This doesn’t mean that a firm’s dividend is ‘bad’, simply that shareholders need to recognise and plan for these fluctuations.
In my view, Admiral has a proven business model that is well suited to the needs of income investors. With a forecast 2015 P/E of almost 16, I’d prefer to pay a little less for the firm’s shares, but I believe they should continue to be a reliable income stock.