High yields typically arise when a company's share price has fallen a long way but the dividend has not been cut. However, the market believes it will be cut -- and the higher the yield, the stronger the market's belief.
The market's often right but now and again it gets it wrong. Today, I'm looking at two companies sporting yields in excess of 9%. Are these yields dangerous ... or too good to ignore?
Shares of low-maintenance building products manufacturer Epwin (LSE: EPWN) are down less than 3% as I'm writing, despite the company saying in its first-half results this morning that it expects the full-year performance to be "slightly below current market expectations."
Furthermore, it said it also now expects the performance for 2018 to be "lower than the market expectation for the current financial year." The analyst consensus ahead of today's results had been for a return to modest growth in 2018. So why has the market not trashed the share price?
Epwin had already notified the market of the potential loss of two customers (10% of revenue) for reasons entirely out of the company's hands. So, that was largely priced-in.
On the wider front, it said that trading conditions in its key repair, maintenance and improvement area "remain subdued" but that management is "confident of the long-term growth drivers" in the market. It also said that the newbuild market "continues to be strong" and that there are "indications of improved demand" in social housing. Meanwhile, it's already begun adjusting its cost base, which should mitigate some of the pressure on margins from higher input costs due to the weakness of sterling.
An attractive dividend?
The board upped the interim dividend by 1.4% today, making the trailing payout 6.63p and giving a running yield of 9.5% at a current share price of 70p. It said: "We are confident in continuing our record of strong cash generation and our ability to offer an attractive dividend to shareholders."
I note that even if 2018 earnings came in 50% lower than the analyst consensus ahead of today's results, the dividend would still be covered. I see this £100m AIM stock as one with recovery potential that might manage to maintain its dividend in the absence of a serious deterioration in trading. As such, I rate it a higher-risk buy.
Another attractive dividend?
Specialist distributor Connect(LSE: CNCT) is another company seeing mixed trading conditions across its businesses in "more challenging market conditions." The recent sale of its Education & Care business looks a good move, as it will enable the group to focus on opportunities and synergies in its News & Media, Parcel Freight and Books divisions.
In its half-year results in April, the board increased the interim dividend by 3.3%, making the trailing payout 9.6p and giving a running yield of 9.3% at a current share price of 103.5p. Management said the uplift in the interim dividend "reflects confidence in the ongoing strength of the group."
I see this £256m FTSE SmallCap stock as another with recovery potential that could provide the bonus of a maintained dividend. So, as with Epwin, I rate Connect as a higher-risk buy.
5 best buys
Clearly, Epwin and Connect's 9%+ yields are not guaranteed. Indeed, I take them more as a signal of recovery potential for capital gains than as top income buys. I believe blue-chip stocks should provide the core of a dividend portfolio. With this in mind, the Motley Fool's experts have been scouting the market to identify the very best FTSE 100 businesses with the ability to deliver top-notch returns through thick and thin.
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G A Chester has no position in any of the shares mentioned. 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.