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Persimmon returns 12.3%, but can you trust the company to deliver?

Persimmon is currently the second highest yielding stock in the FTSE 100. With a dividend yield of 12.3%, the homebulider’s shares look very attractive from an earnings perspective.

However, a high dividend yield (especially in the double digits) can indicate a struggling business. This may be a sign that investors are avoiding stocks, driving down stock value and increasing yield.

So is this the case with Persimmon? Can you trust the dividend – or is the market sending a warning signal?

Real estate market fundamentals show strong foundation for activity

The first place I start when evaluating a company’s dividend credentials is its underlying market. If the underlying market cracks, it may only be a matter of time before that weakness spills over to the organization.

Persimmon is one of the largest home builders in the UK. The average selling price of homes sold to private owner occupiers in his forward order book is £266,000, putting him firmly in the affordable, first-time buyer bracket. This is important because these two markets have different fundamentals from the rest of the real estate market.

Over the past decade the government has introduced a series of new rules giving first-time buyers an edge in the property market. New mortgage products have been introduced with lower deposits, the Lifetime ISA gives savers a head start with a government cash injection, and there is a special stamp duty tax scheme for first-time buyers.

But while these changes have made life easier for first-time buyers, it has become more difficult to climb the property ladder as a whole.

According to Zoopla, the average first-time buyer’s deposit has jumped by more than 50% in a decade, from just under £22,000 to over £45,000. And with interest rates rising, all buyers face higher mortgage costs – and the pain is likely to be felt most by low-deposit mortgage buyers, who are primarily first-time buyers.

Yet there are powerful psychological and financial reasons for buyers to take their first step up the homeownership ladder (as well as environmental reasons – new homes are often more energy efficient).

Additionally, while these buyers face higher costs, they pale in comparison to the costs faced by owners higher up the scale. Buyers who want to acquire a second property not only face higher interest rates, but they also have to take into account an additional stamp duty of 3%.

Indeed, a first-time buyer paying £270,000 for a property (around the average in Great Britain) will pay no stamp duty. Someone moving into a new house will pay £3,500 and buying an additional property will cost £11,600.

Based on these factors, I believe new home sales in England will remain robust going forward and the market should outperform the rest of the property market.

Company growth suggests cash returns will continue

Against this backdrop, I think Persimmon and its peers are unlikely to see a massive drop in demand; demand might slow, but it can afford to lower prices and offer incentives to attract buyers. In its 2021 fiscal year, Persimmon achieved an underlying property gross margin of 31.4%.

Back to the dividend. The company has confirmed its dividend plans for this year. It pays a final dividend of 110p per share in early July to shareholders who held the share on June 17. So far, management has not released any guidance for the rest of the year, although analysts’ estimates from Refinitiv suggest the company will pay out 239p per share for the 2022 financial year and 242p for 2023.

It seems likely that Persimmon will hit those projections: according to its latest business update, it’s on track to build 4% to 7% more homes this year.

Meanwhile, its forward order book stands at £2.8bn, locking in around 74% of sales for 2022 (analysts have estimated total sales for the year at £3.8bn ). And on top of that, Persimmon ended April with £446m of net cash on the balance sheet. This does not take into account the July dividend and land purchases made since that date.

However, it ended its 2021 financial year with £1.2bn in cash. With home completions expected to increase this year and an average sale price up 5.2%. I don’t think it’s unreasonable to say that Persimmon could end 2022 in a similar financial situation.

Based on these factors, I’m pretty confident that Persimmon can meet the city’s dividend targets for the next year or two at least. After that, it’s a little harder to say where the real estate market will go and whether demand will fall. Nonetheless, for now at least, the company’s fundamentals look solid.

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