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Sometimes the FTSE100 is throwing a deal so cheap that I feel like putting all caution aside and buying it, despite the risks. I think I found such a stock.
Home builder Khaki (LSE:PSN) offers the kind of dividend yield that would normally run me a mile. Incredibly, it brings in an income of 18.56%. This is almost double the current rate of inflation.
This is a massive income stock
I would normally consider a massive return like this a red light rather than a green light. Yield is calculated by taking the dividend per share and dividing it by the company’s share price. This means that when the stock price drops, the dividend automatically increases. A high dividend is therefore normally a sign of a stock price crash.
A quick look at Persimmon’s stock chart confirms that’s the case here. It’s a sea of red. Last week it fell 7.02%. Over 12 months, it is down 51.03%. Measured over five years, it is down 45.45%. These are horrible numbers.
Bargain seekers who have had their fill of persimmon stock during this period will lick their wounds. Each drop was followed by another. The return never comes.
I agree that I can quickly find my name on the long list of losers. UK property prices finally look vulnerable as the cost of living crisis intensifies. Affordability is at an all-time high of 9.1 times the average wage, up from 3.55 times in 1997. That’s as dizzying as Persimmon’s performance. Neither can be sustainable.
While reduced stamp duties and a shortage of real estate will partially offset this, at some point buyers will find buying new homes too expensive. Especially if the current sterling crisis forces the Bank of England to raise interest rates even more aggressively.
Still, I would still buy this stock. If Persimmon weren’t facing extreme headwinds, it wouldn’t be trading at an incredibly low forward valuation of 5.5 times earnings. And the yield would not be so high.
The largest producer in the FTSE 100
Its current dividend is covered at just 1.1 times earnings, as is the forward yield of 16.3%. He could make up any shortfall of his £780million but cannot continue to do so. Management can simply decide that the yield is too high and chop it. Yet even if the payout were cut in half, it would still yield 8% or 9% per year.
Another danger is that inflation will drive up construction costs, even though management has partly hedged by bringing many of its activities in-house. Pre-tax profit for the six months to June 30 fell from £480m to £439.7m, while revenue and completions also fell.
Yet Persimmon is still on track to hit up to 15,000 full year completions, with forward sales rates of 90%. Operating margins are 26.6% and return on capital employed is 27.4%. This is hardly a business at risk.
The big, big risk is that property prices will crash, Persimmon shares will fall further and the payout to shareholders will be reduced. Still, I think today’s crazy dividend and valuation justifies taking a risk with a small corner of my portfolio. I want for a minimum of 10 years, ideally 20, or more.