Image source: Getty Images
When it comes to dividend stocks, a double-digit percentage yield is impressive. Shares in this bucket draw a lot of attention, but should be treated carefully. Usually, stocks with a high dividend yield carry an elevated level of risk. So when I saw a company with a very generous yield but that could also be undervalued, I naturally needed to look closer.
Undervalued relative to assets
The stock I’m talking about is the SDCL Energy Efficiency Income Trust (LSE:SEIT). Its current dividend yield is 14.15%, making it the highest-yielding option in the FTSE 250.
A big question relates to how I reached the presumption of it being 52% undervalued. This metric was configured by comparing the net asset value (NAV) to the current share price. With trusts like SDCL, the company’s value is mostly based on the sum of the assets being held. In this case, the assets are energy efficiency and decentralised energy projects across the UK, Europe, North America, and Asia.
Based on the latest reported NAV value, the stock is at a 52% discount. Of course, in a few months, we should get an updated NAV figure, which could see the discount either increase or decrease. But with the stock down 35% in the past year and no major company updates suggesting the portfolio has been significantly hit in value, I don’t see the discount reducing.
Caution still needed
Without a large hit to the NAV, the discount tells me that the share price move is mostly due to negative sentiment. This could put off some investors. Some would flag up worries about renewable and energy-efficiency trusts, saying that the hype around them is dying down. It’s true that some companies are pivoting back to traditional fuels, with volatile commodity prices also to blame.
Another point to note is that the high dividend yield is primarily being driven by the falling share price. But the dividend per share has indeed been increasing each calendar year for several years now. Given that the dividend cover is above one, I’m not concerned about it being paid out. But the falling share price has pushed the yield higher, which is a bit of a red flag.
The bottom line
From where I’m standing, I don’t see any big problems that should justify the negative sentiment around the trust. Yet I appreciate that I may have missed something or that the sector might be heading for a multi-year downtrend before things change. So, I’m seriously considering putting some of my money to work here, but only a small amount. That way, I can still benefit from the high yield but am not going to be seriously impacted if the stock keeps dropping.
This story originally appeared on Motley Fool
