At a general level, the dividend yield of a stock is related to the risk it carries. A stock with a 2% yield usually has a lower risk of the income being cut than a stock with a 10% yield.
Of course, there are exceptions to every rule. So when I spotted a dividend stock with an 18% yield, it caught my interest.
Details of the firm
I’m talking about VPC Specialty Lending Investments (LSE:VSL). It’s rather a mouthful to say, although the name does give a good indication about what the company does. It makes credit investments, lending out money in niche areas such as small business lending, working capital products, consumer finance and real estate.
Due to lending to some more unusual areas of the market, it can often charge higher rates of interest. The profit generated from this, alongside other business operations, provides it with money it can use to pay out as a dividend to shareholders.
It typically pays out four dividends a year. Over the past 12 months, it’s been 2p a quarter. When I add this up and compare it to the current share price, I get a dividend yield figure of 17.84%. This is clearly an ultra-high-yield stock!
A big disconnect
Digging into the business further, I can see why the yield is so high. The share price has fallen by 44% over the past year. This has acted to push the yield up and up.
The company blamed several factors during the 2023 annual report. This ranged from the impact of inflation to high interest rates that put pressure on businesses. It also flagged up that the share price is trading at a large discount to the actual net asset value (NAV) of the investment in the portfolio. This is true, in fact it’s currently at a 43% discount.
In my experience, such a large disconnect usually occurs due to negative investor sentiment. If they believe the company’s unlikely to do well in the future, they might sell the stock despite it being lower than where it should be in theory (on par with the NAV).
This is a bit of a red flag to me when I’m considering whether to buy the stock.
Too much for me
With a market-cap of £126m, VPC isn’t a huge listed company. It’s not a penny stock, but it’s not far away. The risk that’s associated with buying a stock of this size for income is very high. My concern is that the high yield is being driven mostly by the share price fall over the past year. Therefore, I don’t feel it’s massively sustainable as a long-term investor.
I could be wrong, with the share price eventually returning to a fairer level that’s more in line with the NAV. If I bought now and that did occur, I’d be laughing as I’d lock in the yield but also benefit from my capital appreciation!
Ultimately, I think this is a high-risk play. It’s not to say it won’t work out well, but I think I’ll look for some lower-risk options at the moment.
This post was originally published on Motley Fool
