Shares in good quality businesses don’t normally offer dividend yields of 10%. But FTSE 100 house-builder Persimmon (LSE: PSN) is doing exactly that at the moment.
Should investors take advantage of this bumper yield, or head for the hills? Here are three reasons why I might buy Persimmon shares.
Cash-backed payouts
At the end of June, Persimmon had net cash of £1,155m. This works out at about 365p per share. That’s enough to cover this year’s 228p dividend and most of next year’s payout, even if earnings fall to zero.
I don’t’ think that’s likely to happen. Analysts’ forecasts are for earnings of 273p per share in 2018, and 278p per share in 2019. Both of these payouts provide cover for the dividend in their own right.
My view is that even if the new-build housing market starts to slow, investors are likely to receive a cash yield of about 20% from Persimmon over the next two years. This should provide some support for the group’s share price.
Negative sentiment
Persimmon’s share price has fallen by about 25% over the last year. The market is bearish, despite news that forward sales of £987m are 9% higher than at the same point last year.
It seems clear that demand for new housing is still strong. The only remaining headwind seems to be Brexit. If this can be completed without triggering a recession, I believe investor sentiment is likely to improve. Domestic stocks could perform well.
A mispriced stock
I believe Persimmon stock is mispriced. If profits are sustainable at similar levels to this year, then I think the shares are too cheap. If earnings are about to collapse, then the shares are too expensive.
There are compelling arguments in both directions. But the reality is that the group has stacks of cash, very high profit margins, and a strong pipeline of forward sales. On balance, I think the shares deserve a buy rating at this level.
A turnaround I’d buy
Another out-of-favour stock that’s on my watch list is currency and passport printer De La Rue (LSE: DLAR). This stock has fallen by about 50% over the last five years, as the group has battled with changing market conditions, and the unexpected loss of the contract to produce UK passports.
The good news is that management is fighting back and turning the business around. The group’s banknote printing business still accounts for about 80% of revenue. But De La Rue is increasing its effort to expand the more profitable identity and product-authentication divisions, where growth is expected to be much stronger.
Cheap at this price?
Results published on Tuesday show that sales rose by 5% to £257.6m during the first half of the year. Unfortunately, a greater mix of low-margin currency business, plus increased R&D spending, meant that adjusted operating profit fell by 36% to £17m.
Despite this, the board has felt able to maintain the current interim dividend of 8.3p per share. This puts the stock on track to deliver a full-year forecast payout of 25p per share. At around 450p, the stock has a prospective dividend yield of 5.5%.
This business isn’t without risk, but I can see a long-term opportunity here. De La Rue currently trades on just 10 times forecast earnings. If growth improves, I’d expect decent gains from this level. Worth considering as a turnaround buy.