The FTSE 100 has been surprisingly stable over the last year, falling by just 3%, or so. That solidity has largely been driven by a strong performance from oil giants Shell and BP, which alone make up around 15% of the index.
However, many of the smaller companies in the FTSE have logged much bigger share price falls. For example, housebuilders Persimmon (LSE: PSN) and Barratt Developments (LSE: BDEV) have both fallen by around 50% over the last year.
Rising mortgage rates and fears of a recession have prompted shareholders to sell. Barratt and Persimmon shares are now trading at levels last seen at least five years ago.
Neither company has cut its dividend — yet — which means that both stocks offer forecast dividend yields of 10% or more.
Share prices usually bottom out before the real-world economy starts to recover. I’m thinking about buying one of these housebuilders as a contrarian play on a UK recovery.
Persimmon: maybe not
Persimmon’s share price has fallen to 2014 levels over the last year. The stock now offers an incredible forecast yield of 18%.
I’ll start by saying that I think Persimmon’s dividend is very likely to be cut. The reason for this is that the company is currently paying out almost 100% of its profits as dividends each year. If profits fall — which seems likely to me — then the dividend could quickly be left without any earnings cover.
Admittedly, accounting rules would allow the company to continue paying its dividend using its historic ‘retained profits’. However, this could quickly use up Persimmon’s cash reserves, so I’d see it as a short-term solution, at best.
Of course, I could be wrong. Persimmon’s houses are typically sold at more affordable price points than some rivals, so the company continues to trade well, despite soaring mortgage rates.
We’ll find out more when the firm reports its third-quarter trading in early November. But, for me, Persimmon shares aren’t cheap enough yet.
Is FTSE 100 favourite Barratt a better choice?
I’m more positive about Persimmon’s rival Barratt Developments, which sells more expensive homes.
Unlike Persimmon, Barratt shares are now trading below their book value, providing some safety margin against falling property values.
Barratt’s dividend also looks stronger to me. The stock’s forecast yield of 10% is still very high, but this payout is covered twice by forecast earnings. In my view, this makes a dividend cut less likely, even if the value of Barratt’s land and unsold homes falls.
In its third-quarter update, Barratt warned investors of a 35% drop in new sales compared to the same period last year. The company said customers were worried about mortgage rates and struggling with “reduced mortgage availability”.
What I’d do now
Broker forecasts suggest Barratt’s profits could fall by around 10% this year. A further 20% fall is expected in 2023/24, before a recovery in 2024/25.
At this stage, these are only guesses. I think it’s fair to say that things could still get much worse.
However, based on these estimates, my analysis suggests that Barratt’s 10% dividend yield might be sustainable. So I’d consider opening a small position in Barratt shares today, with a view to buying more shares when the company’s performance stabilises.