A FTSE 100 stalwart with an 11% yield and P/E of just 3.9! Is this for real?

Preparing a budget during a pandemic
Preparing a budget during a pandemic

FTSE 100 stock Barratt Developments (LSE:BDEV) offers one of the largest dividend yields on the index. In fact, its 11% yield is approximately twice the average for the UK’s top 100 companies.

But a large dividend yield shouldn’t always be trusted. So let’s take a look at this company’s fortunes and see whether it is right for my portfolio.

A tough year

The past 12 months have been pretty good for housebuilders. Property prices reached record highs and demand remained strong as Britons pushed ahead with delayed house moves. In fact, many developers registered record profits during the period.

In the year to June 30, Barratt said adjusted pre-tax profit grew 14.7% to a record £1.05bn, with revenues up 9.5% at £5.27bn as completions increased 3.9% to 17,908. Completions have now recovered in line with pre-pandemic levels.

However, over the past 12 months, the share price has fallen 51%. And that’s not because of the year past, but the year ahead. I, like other investors, am always trying to work out how a company will be fairing in six-12 months time. And the forecast isn’t looking too good.

A concerning outlook

With the share price falling, the dividend yield has soared and the price-to-earnings (P/E) ratio — a metric for valuing a company — has shrunk. Barratt now has a P/E ratio of just 3.9 — one of the cheapest on the FTSE 100.

This low P/E number either suggests the company is undervalued, as the figure is relatively low, or that something might be wrong and that the current level of profitability is unsustainable.

Unfortunately, in this case, it appears that the level of profitability experienced over the past year is unsustainable and investors have given Barratt, and its housebuilding peers, a wide berth.

Interest rates are rising and may even hit 6% towards next summer. That’s certainly high enough to make potential buyers postpone their mortgage applications. In turn, we’re unlikely to see house prices rise much over the next year. And this is a concern for housebuilders as cost inflation is expected to run at 5%.

The chancellor’s mini-budget is unlikely to improve things. Yes, stamp duty cuts incentivise buying, but it’s concerning to see fiscal and monetary policy working at odds. It’s a budget that will cause more inflationary pressure, which means more Bank of England rate rises and more cost inflation. Neither will be good for Barratt.

A brighter future?

Looking beyond the next year, there’s definitely a brighter future ahead for housebuilders. The UK has an acute housing shortage and demand will pick up when rates fall.

But would I buy this stock now? Well, I already own Barratt stock, and quite frankly it might be too late for me to sell and too early to buy. There could be some further downward pressure on housebuilders in the coming months, but I’ll be buying more when I think the stock has hit its nadir.

As for the 11% dividend yield, it might look very attractive, but with some near-term headwinds, it will probably be unsustainable. I’d expect to see the dividend yield cut. Having said that, a 5.5% yield is still above average.

The post A FTSE 100 stalwart with an 11% yield and P/E of just 3.9! Is this for real? appeared first on The Motley Fool UK.

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James Fox has positions in Barratt Developments. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2022