A high dividend yield can lure many income investors. And following the stock market correction in 2022, finding such opportunities have become far easier. After all, when share prices drop, yields go up.
However, as wonderful as double-digit payout rates sound, they seldom last. Don’t forget dividends are funded through excess cash flow. And if earnings become compromised, they often get cut, or even cancelled. And suddenly, a high yield can drop to zero.
With that in mind, I’m steering clear of Persimmon (LSE:PSN). The homebuilder currently offers a 16.4% dividend yield. Yet some glaring red flags suggest this may be too good to be true. Let’s take a closer look and explore another income stock I believe is the far better buy today.
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The problem with Persimmon’s dividend yield
As a quick reminder, Persimmon is one of the UK’s most active home-building companies. And with demand for housing surging these past two years, especially in 2020 when stamp duty was temporarily suspended, profits have soared.
To capitalise on rising house prices, management ramped up its build rates, and shareholders reaped some impressive dividend payouts. But the gravy train may have now ended.
Looking at a recent trading update, the firm’s forward sales position between January 2021 and 2022 has fallen by 36%. It seems the rising cost of mortgages on the back of interest rate hikes is significantly slowing demand.
While property values are still rising, this upward trend may soon reverse. And with construction material costs still climbing due to inflation, Persimmon’s profit margins are expected to be squeezed in the short term. That means fewer earnings and, in turn, a likely dividend cut.
In fact, based on average analyst consensus, the dividend per share forecast for 2023 is expected to land at 92p – a 50% crash versus 2022. Assuming this forecast is accurate, the firm’s actual dividend yield is likely closer to 6.3%.
That’s still respectable. But with so much uncertainty circling the UK housing market, dividends may once again suffer in 2024, sending the share price down with it.
A better income opportunity?
Fortunately, there’s more than one way to invest in the real estate market. While the residential sector is coming under fire, commercial properties are proving more resilient. And that’s why Londonmetric Property (LSE:LMP) looks like a far better deal, even though its dividend yield only stands at 4.9%.
The firm manages a diverse portfolio of commercial properties that primarily consist of warehouses. While the group has suffered property devaluations, these reported expenses don’t affect cash flow. And despite the slowdown in consumer spending, e-commerce continues to drive up demand for warehousing space.
Consequently, Londonmetric’s earnings are actually up by double digits. Meanwhile, since the company primarily leases to industry-leading enterprises, occupancy levels remain solid at 98.7%, with an average lease length of 12 years. As a result, management just increased dividends pushing the yield higher.
A prolonged downturn in consumer spending will eventually impact occupancy levels. Needless to say, that would make it more challenging to negotiate higher rates on contract renewals. But in the long run, as more shopping is done online, demand for warehousing could be set to rise considerably, potentially pushing up dividends even higher. I’d buy more if I had some cash to spare.
